UC-NRLF 


773 


TAX 


TAXES 


JOSEPH  J.  I  SCOTT 

Former  Collector  of   Internal  Revenue 
at  San  Francisco,  Cal. 


An  Authoritative  Analysis,  Simplification  and  Illustration 

of  the  Exacting  and  Perplexing  Requirements 

of  the  United  States  Tax  Laws. 


Press  of 
KOHNKE  PRINTING  COMPANY 

233  Pine  Street 
San  Francisco,  California 


Copyright  1917 

by 
JOSEPH  J.  SCOTT 


GIFT 


FOREWORD 


This  book  is  intended  for  reference.  It  has  been  written  and  ar- 
ranged for  the  use  of  the  taxpayer  who  must  comply  with  the  exact- 
ing requirements  of  the  Federal  Revenue  laws  but  who  has  not  had 
opportunity  to  follow  the  official  interpretation  and  administration  of 

their  many  intricate  and  involved  provisions. 

t 

It  is  suggested  that  the  index  be  consulted  for  reference  to  the 
subject  regarding  which  information  is  desired;  in  this  way  an  answer 
may  be  found  immediately  to  the  question  in  the  taxpayer's  mind, 
without  unnecessary  reading. 

Toward  the  back  of  the  book  will  be  found  the  text  of  the  laws, 
which  also  can  be  consulted,  according  to  the  direction  of  the  index, 
when  the  taxpayer  would  see  whether  in  his  own  opinion  instructions 
are  in  compliance  with  the  law. 

For  the  reason  that  "net  income",  as  ascertained  under  the  pro- 
visions of  the  Act  of  September  8,  1916 — the  general  Income  Tax  Law, 
is  taken  as  the  basis  of  computation,  not  only  of  the  combined  Income 
Taxes,  but  also  of  the  Excess  Profits  Tax,  it  has  been  deemed  advisa- 
ble to  go  very  thoroughly  into  the  requirements  of  that  Act. 

The  Act  of  September  8,  1916,  as  amended,  has  become,  by  a  wide 
margin,  the  most  important  of  Federal  tax  laws.  It  is  the  funda- 
mental statute.  With  respect  to  it  the  War  Income  Tax  law  is  supple- 
mentary, and  the  Excess  Profits  Tax  law  occupies  a  position  of  re- 
lationship due  to  the  fact  that  "net  income,"  as  ascertained  for  Income 
Tax  purposes,  is  one  of  the  controlling  factors  of  the  computation  of 
the  Excess  Profits  Tax. 

The  instructions  given  in  this  book  are  based  upon  an  experience 
of  four  years  in  administering  Federal  Tax  laws,  as  Collector  of  In- 
ternal Revenue  at  San  Francisco,  Cal.  That  experience  included  the 
inauguration  of  taxation  of  income  under  the  old  law  of  1913  and  con- 
tinued through  the  handling  of  thousands  of  individual  and  corpora- 
tion assessments  under  both  the  law  of  1913  and  the  Act  of  September 
8,  1916. 

Supporting  the  instructions  and  advice  given  in  succeeding  chap- 
ters are  not  only  the  regulations  and  practice  of  the  Treasury  Depart- 

M699156 


nient  and  the  decisions  of  the  Federal  courts  but  also  experience  in 
dealing  with  actual  conditions  when  general  rules  did  not  seem  to  ap- 
ply and  the  problems  that  arose  could  be  solved  only  by  extensive  offi- 
cial correspondence. 

The  taxpayer  is  entitled  to  know  his  rights.  In  this  book  an 
effort  is  made  to  tell  him  what  they  are  and  how  to  claim  them. 

But  the  taxpayer,  judging  by  the  experience  of  the  writer,  desires 
'to  meet  his  obligations  as  well  as  to  be  able  to  assert  his  rights  ;  hence, 
he  is  told  not  only  what  he  can  do  but  also  what  he  must  do. 

The  Income  Tax,  the  Excess  Profits  Tax,  the  Capital  Stock  Tax, 
the  Estate  Tax,  the  new  Stamp  Tax.  and  the  several  other  taxes,  as 
increased  or  originally  imposed  by  the  provisions  of  the  War  Revenue 
Act  are  covered  in  appropriate  chapters,  as  indicated  by  the  Table  of 
Contents. 

'  No  instruction  has  been  given  that  is  not  within  the  law.  Au- 
thority can  be  cited  on  every  point.  The  full  text  of  official  regula- 
tions has  been  omitted,  in  most  cases,  for  the  reason  that,  in  general, 
the  text  of  such  regulations  is  little  less  involved  and  confusing  than 
that  of  the  laws  they  are  intended  to  interpret. 

JOSKIMI    J.    SCOTT. 


TABLE  OF  CONTENTS 


INCOME    TAX 

INTRODUCTORY    Chap.   I Page       9 

COMPUTATION    OF    TAX Chap.   II Page     11 

ON    INDIVIDUAL    INCOME Chap.   Ill Page     19 

INDIVIDUAL    INCOME    SUBJECT    TO , Chap.   IV Page     22 

INCOME    EXEMPT    FROM    TAX Chap.  V Page     39 

DEDUCTIONS    OF    INDIVIDUALS Chap.  VI Page     43 

CREDITS    OF     INDIVIDUALS Chap.  VII Page     57 

FILING    OF    INDIVIDUAL    RETURN Chap.  VIM Page     61 

NON-RESIDENT     ALIENS Chap.   IX Page     66 

PARTNERSHIPS    Chap.  X Page     71 

DEDUCTION    OF    TAX    AND 

INFORMATION    AT    SOURCE Chap.  XI Page     75 

ESTATES    AND    FIDUCIARIES Chap.  XII Page     87 

CORPORATIONS    SUBJECT    TO Chap.  XIII Page     90 

CORPORATIONS     EXEMPT Chap.  XIV Page     99 

CORPORATIONS,    GROSS    INCOME    OF Chap.  XV Page   104 

DEDUCTIONS    OF    CORPORATIONS Chap.  XVI Page   116 

DEPRECIATION    OF    PROPERTY Chap.  XVII Page   139 

DEPLETION    OF    DEPOSITS Chap.  "XVIII Page   149 

FILING    OF    CORPORATION    RETURN Chap.  XIX Page   158 

MISCELLANEOUS     PROVISIONS Chap.  XX Page   166 

ASSESSMENT    AND    PAYMENT    OF   TAX Chap.  XXI Page   196 

PENALTIES,    ETC Chap.  XXII Page  201 

CLAIMS   Chap.  XXIII Page  205 

WAR    INCOME    TAX Chap.  XXIV Page  209 

ILLUSTRATIVE    CASES    (INCOME    TAX) Chap.  XXV Page  215 

EXCESS    PROFITS    TAX Chap.   XXVI Page  235 

I  LLUSTR  ATI  VE    CASES Page  251 

CAPITAL    STOCK    TAX Chap.  XXVII Page  256 

ESTATE     TAX Chap.  XXVIII Page  265 

STAMP    TAXES Chap.  XXIX Page  270 

TAX    ON    INSURANCE    POLICIES Chap.  XXX Page  277 

TAX    ON    TRANSPORTATION,    ETC Chap.  XXXI Page  279 

TAX    ON    ADMISSIONS    AND    DUES Chap.   XXXII Page  283 

TAX    ON     MISCELLANEOUS    ARTICLES Chap.  XXXIII Page  286 

TAX    ON    LIQUORS,    ETC Chap.  XXXIV Page  291 

TAX    ON    SOFT    DRINKS Chap.  XXXV Page  294 

TAX    ON    TOBACCO,    ETC Chap.  XXXVI Page  296 

OCCUPATIONAL    TAXES Chap.  XXXVII Page  298 

COURT    DECISIONS Chap.  XXXVIII Page  300 

TEXT    OF    LAWS 

INCOME    TAX    (Act  of  Sept.  8,  1916,  as  amended) Appendix  Page     1 

WAR    INCOME    TAX    (Act  of  Oct.  3,  1917)  Appendix  Page  23 

EXCESS    PROFITS    TAX Appendix  Page  25 

TAX    ON    BEVERAGES Appendix  Page  31 

TAX    ON    TOBACCO,    ETC. Appendix  Page  36 

TAX    ON    TRANSPORTATION,    ETC Appendix  Page  37 

TAXES    ON    MISCELLANEOUS    ARTICLES Appendix  Page  40 

TAX    ON    ADMISSIONS    AND  DUES Appendix  Page  42 

STAMP    TAXES Appendix  Page  43 

ESTATE    TAX Appendix  Page  48 

ADMINISTRATIVE     PROVISIONS Appendix   Paqe  48 

INDEX  Following    Appendix 


THE   INCOME   TAX 


CHAPTER  I 


THE  INCOME  TAX 


There  are  now  in  effect  two  Federal  Income  Tax  laws.  One  is 
the  Act  of  September  8,  1916  and  the  other  the  Act  of  October  3,  1917. 
The  former  imposes  the  regular  or  ordinary  income  tax  and  the  latter 
the  War  income  tax. 

The  Act  of  October  3,  1917  is  supplementary  to  the  Act  of  Sep- 
tember 8,  1916.  One  of  its  provisions  is  that  it  shall  be  administered 
according  to  the  method  by  which  taxes  are  assessed  under  the  Act  of 
September  8,  1916.  It  imposes  new  taxes  upon  individuals  and  cor- 
porations but  in  its  enforcement  the  Government  will  rely  upon  the 
system  inaugurated  under  the  old  law,  and  both  new  and  old  laws  will 
be  administered  together. 

In  any  study  of  the  practice  and  policy  adopted  by  the  Govern- 
ment in  the  taxation  of  income  the  primary  consideration  is,  there- 
fore, an  understanding  of  what  has  been  done  under  the  Act  of  Sep- 
tember 8,  1916.  There  are  a  few  points  of  difference  between  the  two 
laws,  but  very  few.  The  personal  exemption  is  lowered  by  the  Act  of 
October  3,  1917,  and  the  War  income  tax  is  made  applicable,  as  far  as 
individuals  are  concerned,  only  to  those  persons  who  are  citizens  or 
residents  of  the  United  States.  More  persons  are  subjected  to  the 
additional,  or  super,  tax,  and  corporations  are  given  certain  privileges 
with  respect  to  assessment  of  the  War  income  tax  that  they  do  not 
enjoy  under  the  assessment  of  the  Regular  or  ordinary  income  tax. 

But  the  differences  will  be  explained  and  taken  care  of  in  the  com- 
putation. The  important  consideration  now  is  that  the  administration 
of  the  Act  of  September  8,  1916  must  be  understood  if  either  an  indi- 
vidual or  a  corporation  expects  to  be  able  to  take  advantage  of  the 
rights  allowed  by  law  and  to  meet  the  obligations  imposed. 

For  this  reason  Income  Tax  instructions  will  be  based  almost  en- 
tirely upon  practice  under  the  Act  of  September  8,  1916,  which  is  still 
the  principal  income  tax  law  with  the  War  income  tax  serving,  as  it 


•10  THE    INCOME   TAX 

were,  only  to  bring  more  persons  under  this  system  of  taxation  and 
make  the  incomes  of  those  who  have  not  heretofore  enjoyed  exemp- 
tion bear  a  far  heavier  part  of  the  country's  tax  burden. 

It  is  thought  that  the  question  of  one's  income  tax  liability  (a.s 
either  individual  or  corporation)  can  be  ascertained  by  consulting  the 
appropriate  chapters,  paragraphs  or  parts  of  the  general  income  tax 
instructions  that  follow.  Wherein  any  of  such  instructions  do  not 
apply  to  the  War  Income  Tax  is  explained  in  the  chapter  on  "War  In- 
come Tax." 

Only  one  return  will  be  required  of  any  individual  or  corporation 
lor  the  assessment  of  income  tax  under  both  laws.  The  computation 
must,  therefore,  take  cognizance  of  the  rates  imposed  by  both  laws. 
And  in  order  that  the  general  scheme  of  computation  of  tax  liability, 
according  to  the  schedules  of  both  laws,  may  be  understood  at  the 
outset,  a  condensed  version  of  it  is  given  and  illustrated  in  the  next 
succeeding  chapter. 


THE   INCOME  TAX  II 


CHAPTER  II 


THE  INCOME  TAX 


COMPUTATION    OF    INCOME   TAX 

UNDER 
BOTH  LAWS. 


There  follow  condensed  instructions  for  computing  both  an  indi- 
vidual and  a  corporation  income  tax  under  the  rates  of  both  Income 
Tax  laws  now  in  effect  (Act  of  September  8,  1916  and  Act  of  October 
3,  1917.)  All  of  the  points  in  this  chapter  are  explained  in  more  detail 
elsewhere  in  this  book  under  appropriate  headings.  It  is  not  expected 
that  instructions  relative  to  the  treatment  of  net  income  can  be  fol- 
lowed until  the  meaning  of  "net  income,"  according  to  the  law  and 
regulations  and  Treasury  Department  practice,  is  understood — until 
the  taxpayer  will  have  submitted  his  own  particular  case  to  the  defini- 
tions, explanations  and  illustrations  given  in  succeeding  chapters. 
But  in  order  that  the  taxpayer  may  have  in  mind  from  the  outset  an 
administration  of  the  two  income  tax  laws  together  the  combined 
computation  is  outlined  here.  Reference  should  be  made  bac'k  to  this 
chapter  as  other  chapters  or  paragraphs  are  consulted. 

1.— WHAT   IS   MEANT  BY   "NET   INCOME." 

The  first  thing  to  be  understood  is  what  is  meant  by  "net  income," 
as  the  phrase  is  used  in  the  law.  Many  persons  have  their  own  ideas 
regarding  that  part  of  income  which  is  "net,"  but  these  ideas  will 
have  to  be  laid  aside  if  they  do  not  agree  with  the  significance  of  the 
term  as  used  in  the  statute. 


The  net  income  of  either  an  individual  or  a  corporation  is  the 
difference  between  total  gross  income  and  the  aggregate  of  certain 
specified  deductions. 


]?  THE    INCOME   TAX 

The  net  income  of  an  individual  is  the  difference  between  total 
gross  income  and  the  aggregate  of  deductions  allowed  for  business 
expenses,  taxes,  interest,  bad  debts,  losses  and  certain  gifts  to  charita- 
ble, religious  or  educational  organizations.  Net  income  is  ascertained 
before  account  is  taken  of  any  other  credit  allowed  in  the  subsequent 
computation  of  tax. 

The  net  income  of  a  corporation  is,  likewise,  the  difference  be- 
tween total  gross  income  and  the  aggregate  of  allowable  deductions — 
such  deductions,  in  the  case  of  a  corporation,  being  for  ordinary  and 
necessary  business  operating  expenses,  losses,  interest,  and  taxes. 
The  result  at  this  point  is  net  income,  within  the  meaning  of  the  law, 
before  account  is  taken  of  any  other  credit  that  may  be  considered 
later  in  computing  tax  liability. 

2.— THOSE  WHO  MUST  FILE  RETURNS. 

Under  the  operation  of  both  laws  a  return  must  be  filed  by 

(a)  Every  individual   who    is   a   citizen   or    resident   of   the 
United  States,  and  who,  if   single,  has   a   net  income  of 
$1,000  or  more,  or,  if  married,  a  net  income  of  $2,000  or 
more,  for  the  Calendar  year. 

(b)  Every  alien  who  is  not  a  resident  of  the  United  States 
and   who   has    a   net    income    from   sources   within   the 
United    States    amounting   to   $3,000   or   more    for    the 
Calendar  year. 

(c)  Every  domestic  corporation,  whatever  the  amount  of  its 
income,  and  even  though  it  have  none,  except  those  of  a 
character    specifically    exempted.      (See    "Corporations 
Exempt.") 

(d)  Every  foreign  corporation  (subject  to  same  exemption 
as  to  character)  of  its  income  from  sources  within  the 
United  States. 

(e)  Certain  estates,  as  explained  in  appropriate  paragraphs. 
(See  index). 

3.— ONE  RETURN  UNDER  BOTH  LAWS. 

Only  one  return  of  income  will  be  required  by  the  Government 
from  either  an  individual  or  a  corporation.  Upon  the  basis  of  net  in- 
come shown  by  this  one  return  total  tax  liability  will  be  ascertained 
according  to  the  rates  imposed  by  both  the  old  law  (Act  of  September 
8,  1916)  and  the  new  law  (Act  of  October  3,  1917.) 


THE   INCOME  TAX  13 

4.— COMPUTATION  OF   INDIVIDUAL  TAX. 

The  income  tax  liability  of  an  individual  who  is  a  citizen  or  resi- 
dent of  the  United  States  will  be  ascertained,  in  general,  as  follows : 

(1)   Determine  Net  Income. 

Determine  net  income  by  subtracting  from  gross  income  the  total 
of  allowable  deductions.  By  "deductions"  are  not  meant  the  credits 
allowed  for  dividends,  income  taxed  at  the  source,  the  specific  exemp- 
tion and  the  amount  of  Excess  Profits  tax  assessed  for  the  same  year. 
By  "deductions"  are  meant  only  the  allowances  for  business  expenses, 
taxes,  interest,  losses,  bad  debts,  depreciation,  depletion  and  gifts  to 
certain  organizations. 

(2)  Credit  for  Excess  Profits  Tax. 

Credit  net  income,  ascertained  as  just  explained,  with  the  amount 
of  Excess  Profits  Tax  assessed  for  the  same  year.  The  result,  at  this 
point,  is  the  only  basis  of  assessment  of  any  income  tax. 

(3)  Get  Normal  Tax  Basis. 

Ascertain  basis  of  computation  of  the  normal  tax  by  taking  credit 
for  that  part  of  net  income  represented  by  dividends  from  corpora- 
tions, if  any.  Dividends  in  the  hands  of  an  individual  are  not  subject 
to  the  normal  tax. 

(4)  Ascertain  Exemption. 

Next  ascertain  the  specific  exemption  allowed  under  both  the  new 
law  and  the  old  law — $1,000  for  a  single  person  and  $2,000  for  a 
married  person  or  the  head  of  a  family,  with  an  additional  allowance 
of  $200  for  each  dependent  child,  under  the  new  law ;  and  $3,000  for  a 
single  person  and  $4,000  for  a  married  person  or  the  head  of  a  family, 
with  an  additional  allowance  of  $200  for  each  dependent  child,  under 
the  old  law. 

(5)  Compute  Normal  Tax. 

Next  compute  normal  tax  as  follows :  (a)  At  the  new  law  rate  of 
2  per  cent  on  the  amount  in  excess  of  $1,000  and  not  in  excess  of 


1.4}  THE   INCOME   TAX 

$3,000  in  the  case  of  a  single  person,  and  on  the  amount  in  excess  of 
$2,000  and  not  in  excess  of  $4,000  in  the  case  of  a  married  person  or 
the  head  of  a  family;  (b)  at  the  rate  of  4  per  cent  (combining  the  2 
per  cent  rate  of  the  old  law  and  the  2  per  cent  rate  of  the  new  law) 
on  the  amount  in  excess  of  $3,000  in  the  case  of  a  single  person  and 
on  the  amount  in  excess  of  $4,000  in  the  case  of  a  married  person  or 
the  head  of  a  family.  Should  a  married  person  or  the  head  of  a  family 
be  entitled  to  the  additional  exemption  of  $200  for  each  dependent 
child,  the  amount  of  income  subject  to  tax  only  at  the  2  per  cent  rate 
of  the  new  law  would  be  the  amount  in  excess  of  ($2,000  plus  the  addi- 
tional exemption  for  dependent  children)  and  not  in  excess  of  ($4,OC* 
plus  the  additional  exemption  for  dependent  children)  and  tax  would 
he  imposed  at  the  rate  of  4  per  cent  (combined  rates)  only  on  net  in- 
come in  excess  of  ($4,000  plus  the  additional  exemption  for  dependent 
children.)  For  instance  :  a  married  person  with  one  dependent  child 
would  be  taxed  at  the  rate  of  2  per  cent  on  net  income  between  $2,200 
and  $4,200  and  at  the  rate  of  4  per  cent  on  net  income  in  excess  of 
$4,200,  and  so  on  with  the  amount  determining  the  tax  rate  increased 
by  $200  for  each  dependent  child. 

(6)   Deduct  Normal  Tax  Withheld. 

Having  ascertained  total  normal  tax  liability,  the"  individual  is  en- 
titled to  deduct  from  the  amount  of  such  liability  any  amount  of  nor- 
mal tax  which  has  been  withheld  at  the  source,  and  the  remainder  is 
the  amount  of  normal  tax  still  due  the  Government. 

(7)   Get  Additional  Tax  Basis. 

Ascertain  the  basis  of  computation  of  additional  tax  by  reverting 
to  the  amount  of  net  income  before  dividends  were  deducted.  While 
dividends  in  the  hands  of  the  individual  are  not  subject  to  normal  tax, 
they  are  subject  to  additional  tax.  Therefore,  go  back  to  the  result 
that  was  obtained  wrhen  steps  No.  1  and  No.  2,  above,  had  been  taken. 

If  the  amount  of  net  income,  as  ascertained  at  the  end  of  step  X<>. 
2,  is  not  in  excess  of  $5,000  no  additional  tax  is  due  ;  if  it  is  in  excess 
of  $5,000,  additional  tax  liability  may  be  ascertained  by  considering 
the  ascending  rate  scales  of  both  the  old  and  the  new  laws.  The  addi- 
tional tax  rates  of  the  new  law  alone  apply  if  net  income  does  not  ex- 
ceed $20,000  and  the  combined  additional  tax  rates  if  net  income  does 
exceed  $20,000. 


THE    INCOME    TAX 


'15 


The  following  table  shows  the  application  of  each  rate  scale  and 
of  the  two  .combined  : 

Net  Income  In  Excess  of — 


Old 
Law 

New 
Law 

.  Com- 
bined 

5,000  and  not  in 

excess  of  $   7,500 

0% 

1% 

\% 

7,500  "  "   " 
10,000  "  "  " 

10,000 
12.500 

0 
0 

2 
3 

Z 
3 

12,500  "  "  " 

15,000 

0 

4 

4 

15.000  "  "  " 

20,000 

0 

5 

5 

20.000  "  "  " 

40,000 

1 

7 

8 

40,000  "  "  " 
60,000  "  "  " 

60,000 
80,000 

2 
3 

io 

14 

12 
17 

80,000  "  "  " 

100,000 

4 

18 

22 

100,000  "  "  " 

150,000 

5 

22 

27 

150.000  "  "  " 
200,000  "  "  " 

200,000 
250,000 

6 

7 

25 
30 

31 

37 

250.000  "  "  " 
300,000  "  "  " 

300,000 
500,000 

8 
9 

34 
37 

42 
46 

500,000  "  "  " 
750.000  "  "  " 

750,000 
"   1,000,000 

10 
10 

40 

45 

50  : 

55 

1,000,000  "  "  " 

"   1,500,000 

11 

50 

61 

1.500,000  "  "  " 
All  in  excess  of... 

"  2,000.000 
...2.000.000 

12 
13 

50 
50 

62 
63 

5—  EXAMPLES  OF   INDIVIDUAL 
TAX  COMPUTATION. 

Xote  preceding  instructions  as  applied  in  the  following  illustra- 
tions : 


No.  1 
John  Smith  ic  single  with  a  net  income  of  less  than  $1,000. 

Me  is  not  required  even  to  file  a  return. 


No.  2 

William  Jones  is  married  with  a  net  income  of  less  than 
$1,000. 

He  is  not  required  even  to  file  a  return. 


16  THE   INCOME   TAX 

No.  3 

Peter  Brown  is  single,  with  no  one  dependent  on  him  for 
support  and  with  a  net  income  of  $1,500. 

He  is  required  to  file  a  return  and  pay  a  tax  of  2  per  cent  on  $500. 


No.  4 

Arthur  Burns  is  single,  with  a  net  income  of  $1,500,  but 
his  aged  mother  is  dependent  on  him  for  support. 

He  is  the  head  of  a  family.    He  should  file  return  but  in  it  claim 
exemption  of  $2,000  and  thus  have  no  tax  to  pay. 


No.  5 

William  Tupper  is  married  and  lives   with  his  wife  and 
six-year-old  son.    His  net  income  is  $6,000. 

His  exemption  under  the  new  law  is  ($2,000  plus  $200)  and  under 
the  old  law  is  ($4,000  plus  $200).  He  is  taxed  at  the  rate  of  2  per  cent 
on  the  $2,000  between  the  new  law  exemption  of  $2,200  and  the  old 
law  exemption  of  $4,200 ;  and  at  the  rate  of  4  per  cent  on  the  $1,800 
in  excess  of  $4,200.  But  he  is  also  subject  to  additional  tax  under  the 
new  law,  which  is  figured  at  the  rate  of  1  per  cent  on  the  amount  of 
$1,000,  which  is  in  excess  of  $5,000,  but  not  in  excess  of  $7,500.  None 
of  his  income  consists  of  dividends ;  no  Excess  Profits  Tax  has  been 
assessed  for  the  same  year,  and  none  of  his  income  has  been  taxed  at 
the  source.  In  such  circumstances,  Tupper's  total  tax  liability  is  $40 
plus  $72  plus  $10  or  $122. 


No.  6 

John  Morrison  is  a  widower  supporting  two  daughters, 
aged  6  and  9,  respectively.  He  is  a  lawyer  by  profession. 
His  net  income  is  $52,000.  It  is  all  from  the  practice  of  his 
profession  except  the  amount  of  $800,  representing  a  dividend 
on  oil  stock.  The  amount  of  his  Excess  Profits  Tax  for  the 
same  year  figures  (for  the  purpose  of  this  example)  $3,680. 

His  exemption  under  the  new  law  is  $2,400  and  under  the  old  law 
$4,400.  After  deducting  from  his  net  income  of  $52,000,  the  amount 
of  his  Excess  Profits  Tax,  which  is  $3,680,  there  is  a  remainder  of 


THE    INCOME    TAX  17 

$48,320  on  which  income  tax  must  be  paid.  However,  from  such  re- 
mainder should  be  deducted  the  $800  dividend  in  order  to  ascertain 
normal  tax  liability.  This  having  been  done,  Morrison  finds  that  he 
has  $47,520  on  which  to  compute  his  normal  tax  and  he  proceeds  to  do 
so  as  follows : 

2  per  cent  on  the  amount  of  $2,000  between  $2,400  and  $4,400 ; 
and  4  per  cent  on  all  of  the  $47,520  above  $4,400.  In  other  words,  2 
per  cent  of  $2,000  and  4  per  cent  of  $43,120,  which  results  in  normal 
tax  liability  of  $1764.80. 

Then  Morrison  turns  to  the  additional  tax  computation.  He  goes 
back  to  the  amount  obtained  when  he  deducted  from  his  net  income 
the  amount  of  his  Excess  Profits  Tax.  On  such  amount,  $48,320,  he 
figures  his  additional  tax,  as  follows : 

On  the  $2,500  between  $5,000  and  $7,500  at  1  per  cent,  $25. 
On  the  $2,500  between  $7,500  and  $10,000  at  2  per  cent,  $50. 
On  the  $2,500  between  $10,000  and  $12,500  at  3  per  cent,  $75. 
On  the  $2,500  between  $12,500  and  $15,000  at  4  per  cent,  $100. 
On  the  $5,000  between  $15,000  and  $20,000  at  5  per  cent,  $250. 
On  the  $20,000  between  $20,000  and  $40,000  at  8  per  cent,  $1,600. 
On  $8,320  (over  $40,000  but   not   over  $60,000)    at    12  per   cent, 
$998.40. 

The  above  computation  gives  a  total  additional  tax  liability  of 
$3098.40.  The  addition  of  this  amount  to  the  normal  tax  of  $1,764.80 
shows  Morrison's  total  income  tax  liability  in  such  circumstances  to 
be  $4,863.20. 

6.— COMPUTATION  OF  CORPORATION  TAX. 

The  income  tax  liability  of  a  domestic  corporation  under  both  the 
old  and  the  new  laws  will  be  ascertained,  in  general,  as  follows : 

(1)  Determine  Net  Income. 

Determine  net  income  by  subtracting  from  gross  income  the  total 
of  allowable  deductions.  By  "deductions"  are  not  meant  the  credit 
allowed  under  the  new  law  (but  not  under  the  old)  for  dividends  re- 
ceived from  another  corporation  and  that  given  under  both  laws  for 
the  amount  of  Excess  Profits  Tax  assessed  for  the  same  year.  By 
"deductions"  are  meant  only  the  allowances  for  actual  and  necessary 
business  operating  expenses,  losses,  depreciation,  depletion,  interest, 
and  taxes. 


18  THE    INCOME   TAX 

(2)  Credit  for  Excess  Profits  Tax. 

Credit  net  income,  ascertained  as  just  explained,  with  the  amount 
of  Excess  Profits  Tax  assessed  for  the  same  year.  The  result,  at  this 
point,  is  the  only  basis  of  assessment  of  any  income  tax. 

(3)  Compute  Tax  Under  Old  Law. 

On  the  amount  of  net  income  shown  when  Steps  No.  1  and  No.  2. 
just  above,  have  been  taken,  compute  tax  at  the  rate  of  2  per  cent — on 
the  entire  amount  of  net  income  thus  shown,  without  any  credit  for 
dividends  received  from  another  corporation. 

(4)   Compute  Tax  Under  New  Law. 

From  the  amount  of  net  income  shown  when  Steps  No.  1  and  No. 
2,  just  above,  have  been  taken,  deduct  the  amount  of  income  repre- 
sented by  dividends  from  another  corporation.  On  the  remainder 
compute  tax  at  the  rate  of  4  per  cent. 

(5)  Total  Tax  Liability. 

Ascertain  total  tax  liability  for  the  year  by  adding  the  amount  due 
at  the  old  rate  and  the  amount  due  at  the  rate  imposed  by  the  new 
law. 


THE*   INCOME    TAX  19 


CHAPTER  III 


THE  INCOME  TAX 


OLD   LAW— ACT  OF   SEPT.  8,  1916 


TAX   ON   INDIVIDUAL   INCOME 


7.— WHO  ARE   LIABLE. 

There  are  three  classes  of  individuals  liable  to  income  tax. 

(a)  A  citizen  of  the  United  States  is  subject  to  the  require- 
ments of  the   law,  whether  Or  not  he   is  a   resident  of  the 
United  States,  and  must  pay  tax  upon  his  entire  net  income, 
less  any  specific  exemptions  and  deductions  allowed  by  the 
law. 

(b)  An  alien  residing  in  the  United  States  is  under  exactly 
the  same  liability  as  a  citizen  of  the  country. 

(c)  An  alien  who  does  not  reside  in  the  United  States,  but 
with  interests  in  this  country,  is  subject  to  the  law  with  re- 
spect to  his  income  from  all  sources  within  the  United  States. 

8.— NO  RELIEF   FROM  TAX. 

No  person,  liable  under  the  income-tax  law  of  the  United  States 
can  claim  exemption  from  tax  by  reason  of  payment  of  an  income  tax 
in  another  country.  This  ruling  applies  to  both  citizens  of  the  United 
States  and  aliens,  resident  and  non-resident. 

It  also  follows  that  liability  to  the  federal  income  tax  is  ift  no 
way  affected  by  payment  of  an  income  tax  imposed  by  any  state. 

9.— PARTNERS   ONLY  AS   INDIVIDUALS. 

Members  of  partnerships  are  liable  for  income  tax  only  in  tlu'ir 
individual  capacity.     Each  is  required  to  take  into  account  his  share 


20  THE   INCOME   TAX 

of  the  earnings  of  the  partnership  in  which  he  is  interested  in  deter- 
mining the  question  of  his  own  individual  liability.  This  question  will 
be  gone  into  fully,  however,  under  the  heading  of  "Partnerships." 

10.— RATES  OF  TAX— ACT  OF  SEPT.  8,  1916. 

The  income  tax,  in  the  aggregate,  consists  of  a  tax  levied  at  a 
flat  rate  upon  entire  net  income,  known  as  the  Normal  tax,  and  a  tax 
levied  on  total  net  income,  according  to  an  ascending  scale  of  assess- 
ment, when  net  income  is  in  excess  of  $20,000  for  the  taxable  year — 
known  as  the  Additional  Tax. 

Note — Often  this  additional  tax  is  referred  to  as  the 
"sur-tax"  or  "super-tax."  In  any  event  the  meaning  of  the 
prefix  should  be  obvious. 

11.— NORMAL  TAX  RATE— ACT  OF  SEPT.  8,  1916. 

The  Normal  Tax  rate  is  2  per  cent. 
12.— ADDITIONAL  TAX  RATES— ACT  OF  SEPT.  8,  1916. 

The  Additional  tax  rate  is  imposed  according  to  the  following 
scale  : 

1  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $20,000  and  does  not  exceed  $40,000, 

2  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $40,000  and  does  not  exceed  $60,000, 

3  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $60,000  and  does  not  exceed  $80,000, 

4  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $80,000  and  does  not  exceed  $100,000. 

5  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $100,000  and  does  not  exceed  $150,000, 

6  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $150,000  and  does  not  exceed  $200,000, 

7  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $200,000  and  does  not  exceed  $250,000, 

8  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $250,000  and  does  not  exceed  $300,000, 

9  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $300,000  and  does  not  exceed  $500,000, 

10  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $500,000  and  does  not  exceed  $1,000,000, 

11  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $1,000,000  and  does  not  exceed  $1,500,000, 


THE    INCOME   TAX  21 

12  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $1,500,000  and  does  not  exceed  $2,000,000, 

13  per  cent  upon  the  amount  by  which  total  net  income  ex- 
ceeds $2,000,000. 


22  THE    INCOME   TAX 


CHAPTER   IV 


THE  INCOME  TAX 


INCOME   SUBJECT  TO  TAX 


INDIVIDUALS 


13.— INCOME   FROM   ALL   SOURCES. 

The  statute  makes  entire  net  income,  from  all  sources  during 
the  taxable  year  (which,  in  the  case  of  individuals,  is  the  calendar 
year)  taxable  with  respect  to  the  liability  of  citizens  and  resident 
aliens,  and  entire  net  income  received  from  all  sources  within  the  Unit- 
ed States,  with  respect  to  the  liability  of  non-resident  aliens.  At  the 
same  time,  however,  the  statute  specifically  exempts  from  tax,  and 
even  from  the  computation  for  tax,  income  from  certain  sources. 
But,  in  the  main,  all  net  income  is  taxable,  provided  it  is  received 
by  the  individual  in  sufficient  quantity  to  exceed  the  exemption 
allowed  every  person.  The  exceptions  will  be  taken  up  later. 

According  to  the  law  the  net  income  of  a  taxable  person  shall 
include  gains,  profits  and  income  derived  from 

(a)  salaries,  wages,  or  compensation  for  personal  service  of  what- 
ever kind  and  in  whatever  form  paid, 

(b)  or  from  professions,  vocations,  businesses,  trade,  commerce, 
or  sales,  or  dealings  in  property,  whether  real  or  personal,  grow- 
ing out  of  the  ownership  or  use  of  or  interest  in  real  or  personal 
property, 

(c)  also   from  interest,  rent,   dividends,   securities,  or  the  trans- 
action of  any  business  carried  on  for  gain  or  profit, 

(d)  or  gains,  or  profits  and  income  derived  from  any  source  what- 
ever. 


THE    INCOME   TAX  23 

It  is  obvious  from  the  above  that  Congress  intended  to  close 
every  possible  avenue  of  escape  from  tax  liability.  The  language  of 
the  law  is  so  comprehensive  and  sweeping  that  no  other  conclusion 
can  be  drawn.  Naturally,  then  the  rulings  of  the  Treasury  Depart- 
ment, opinions  of  the  Attorney-General  and  decisions  of  the  United 
States  Courts  show  little  patience  with  technicalities  but  insist  that 
the  fundamental  purpose  of  the  law  be  faithfully  followed  by  sub- 
mission to  taxation  of  all  net  income  except  that  from  the  few  sources 
specifically  exempted  . 

And,  yet,  innumerable  problems  have  arisen  and  many  finely 
drawn  decisions  have  had  to  be  issued.  Close  distinctions  between 
income  and  capital  transactions  have  had  to  be  made. 

14.— ONLY   INCOME   "RECEIVED." 

Under  the  first  income  tax  law  (Act  of  October  3,  1913)  income 
"accrued",  as  well  as  income  "received,"  had  to  be  included  in  a  return 
and  became  subject  to  tax.  This  requirement  gave  rise  to  a  great 
deal  of  confusion  and  inexcusable  inequity.  With  >such  a  provision  in 
the  statute  it  was  impossible  to  administer  the  act  fairly.  But  this 
condition  was  remedied  by  the  Act  of  September  8,  1916  and  only 
income  "received"  now  need  be  included  in  a  return  for  a  particular 
taxable  year. 

15.— PROFESSIONAL   FEES   AND   SALARIES. 

It  is  a  matter  of  quite  common  occurrence  that  compensation 
for  personal  service  is  not  paid  within  the  year  during  which  it  is 
earned,  that  is  within  the  calendar  year  for  which  the  individual  is  re- 
quired to  file  a  return.  For  instance,  service  rendered  during  the  year 
1916  may  not  have  been  paid  for  until  sometime  in  the  year  1917. 

At  first  the  Government  requirement  was  that  the  individual, 
in  filing  return  for  the  year  during  which  the  service  was  rendered 
include  in  the  retirn  for  that  year  the  charge  for  the  service,  even 
though  payment  had  not  been  made.  Now,  however,  the  person  in 
receipt  of  compensation  for  personal  service,  in  making  return  of 
income  accounts  for  only  the  amounts  received  during  the  year.  A 
salary  or  fee,  earned  in  1917,  but  not  paid  until  'Sometime  in  1918,  need 
not  be  accounted  for  in  the  return  for  1917,  but  can.be  included  in 
the  return  for  1918.  Such  is  the  present  ruling  of  the  Treasury 
Department,  and  it  is  especially  applicable  to  the  accounting  diffi- 
culties of  lawyers,  physicians  and  engineers,  as  well  as  to  any  salaried 
person  in  receipt  of  a  bonus,  in  addition  to  his  salary,  such  bonus 
being  generally  determinable  only  after  the  close  of  the  year  in  which 
earned. 


24  THE   INCOME   TAX 

16.— BONUS  TAXABLE. 

In  some  cases,  of  course,  a  bonus  is  clearly  a  gratuity ;  but,  in 
general,  a  bonus  to  an  employee  represents  additional  compensation 
for  service  rendered  by  him  and  is  based  upon  that  service.  When 
a  special  payment  is  made  as  extra  compensation  in  pursuance  of  a 
contract  express  or  implied,  it  becomes  income  to  the  employee 
and  is  subject  to  tax.  It  cannot  be  regarded  as  a  gift  and  is  not  there- 
fore in  such  circumstances,  exempt  from  tax,  as  would  be  a  payment 
clearly  a  gift. 

17.— LIVING  QUARTERS. 

When  an  individual  is  furnished  living  quarters  in  addition  to 
salary  the  actual  rental  value  of  such  quarters  is  regarded  as  addi- 
tional compensation  subject  to  the  income  tax.  This  ruling  applies 
to  quarters  for  either  the  individual  or  the  individual's  family,  or 
both;  and  it  is  necessary  that  the  rental  value  of  the  quarters  be 
ascertained  with  all  possible  accuracy.  When  such  value  has  been 
ascertained  the  amount  for  the  year  should  be  added  to  the  com- 
pensation for  the  year  and  this  should  be  included  in  the  return  for 
the  year. 

In  the  case  of  Government  officers  this  requirement  is  extended 
to  cover  commutation  of  quarters  and  the  money  equivalent  of 
quarters  furnished  in  kind.  In  this  respect  the  ruling  is  that,  when 
quarters  are  furnished  in  kind,  of  a  less  number  of  rooms  than  the 
number  allowed  by  law,  the  money  equivalent  only  of  the  number  of 
rooms  actually  assigned  shall  be  included  in  income  for  taxation. 
When  quarters  are  furnished  in  kind  of  a  greater  number  of  rooms 
than  the  number  allowed  by  law,  the  money  equivalent  only  of  the 
number  of  rooms  allowed  by  law  shall  be  returned. 

18.— HEAT  AND  LIGHT  ALLOWANCE. 

Likewise,  amounts  received  by  an  officer  for  heat  and  light  must 
be  returned  for  tax ;  or,  if  the  officer  occupies  public  quarters,  the 
money  equivalent  of  the  heat  and  light  furnished  him,  as  fixed  by  the 
Government  must  be  returned,  it  being  the  contention  of  the  Treasury 
Department  that  by  such  amount  is  his  compensation  increased. 

19.— MILEAGE. 

The  difference  between  the  amount  received  as  mileage  and  the 
amount  of  actual  expense  of  travel  must  be  returned  for  tax.  The 
Treasury  Department's  ruling  on  this  point  affects,  in  general,  only 
officers  and  employees  of  the  Government. 


THE    INCOME   TAX  25 


20.— COMMISSIONS. 


Payments  received  by  a  taxable  person  in  the  form  of  com- 
missions are  income  subject  to  tax  and  must  be  returned  by  the  sales- 
man for  the  year  in  which  received. 

21.— RENEWAL   PREMIUM   COMMISSIONS. 

Commissions  on  renewal  premiums  for  insurance  are  taxable 
income  for  the  year  in  which  received,  without  respect  to  the  date  of 
issue  of  the  policy.  This  means  that  commissions  received  on  renewal 
premiums  for  insurance  written  prior  to  the  incidence  of  the  income 
tax  must  be  included  in  the  individual's  return. 

22.— CLERGYMEN'S  FEES. 

A  close  definition  has  been  drawn  by  the  Treasury  Depart- 
ment with  respect  to  the  so-called  offerings  and  fees  received  by 
clergymen.  It  is  held  that  such  offerings,  received  on  Easter,  for 
instance,  or  for  funerals,  masses,  marriages,  baptisms  and  the  other 
services  rendered  by  a  clergyman,  are  income  sublet  to  tax.  A 
Christmas  gift  to  a  clergyman,  however,  even  though  in  the  form 
of  money,  is  not  taxable  income  to  him. 

23.— TRUSTEE'S  COMPENSATION. 

A  trustee  of  an  estate  must  return  for  tax  the  amount  he 
receives  for  his  services,  and  in  the  year  he  receives  it.  The  sig- 
nificance of  this  ruling  by  the  Treasury  Department  will  be  appreci- 
ated when  it  is  understood  that  in  the  ruling  it  is  also  held  that  if  no 
determination  was  made  with  respect  to  the  trustee's  compensation 
over  a  period  of  years  until  the  trust  was  terminated,  the  amount 
finally  allowed  must  be  returned  in  full  for  the  year  in  which  paid. 
The  amount  cannot  be  prorated  over  the  period  during  which  the 
trustee  served.  All  is  subject  to  tax  for  the  year  in  which  received. 

24.— RENT. 

Rent  should  be  returned  as  income  subject  to  tax  for  the  year 
in  which  received.  For  instance,  a  landlord  may  not  have  received  his 
rent  for  the  month  of  December,  1916,  until  early  in  January,  1917. 
While  the  payment  actually  was  for  the  use  of  the  property  in  the 
year  1916,  it  was  not  received  until  the  year  1917,  and,  therefore, 
should  be  included  in  the  landlord's  return  for  1917,  instead  of  in  his 
return  for  1916. 

Board,  lodging  or  other  consideration  received  in  lieu  of  cash 
rent  is  income  subject  to  tax  and  its  equivalent  must  be  included  in  the 
recipient's  return. 


26  THE    INCOME   TAX 

25.— DIVIDENDS— CASH   AND  STOCK. 

Dividends  are  income  to  the  recipient  and  must  be  included  in 
the  individual's  return.  Moreover,  dividends  are  income,  whether  paid 
in  cash  or  in  stock. 

The  stock  dividend  must  be  included  to  the  amount  of  the 
earnings  or  profits  of  the  distributing  corporation. 

26.— DIVIDENDS— HOW  TAXABLE. 

While  a  dividend  must  be  included  by  the  individual  in  his 
return  of  gross  income,  the  amount  of  it  is  allowed  as  a  credit  against 
net  income  for  the  purpose  of  the  normal  tax. 

The  amount  of  the  dividend  is  not  allowed  as  a  credit  for  the 
purpose  of  the  additional  tax,  however.  It  is  subject  to  the  additional 
tax  and  enters  in  full  into  the  computation,  according  to  the  ascending 
scale  of  assessment. 

27.— VALUE  OF  STOCK  DIVIDEND. 

A  stock  dividend  should  be  returned  by  the  shareholder  re- 
ceiving it  at  the  amount  it  represents  in  the  distribution  made  by  the 
corporation  which  has  paid  it.  In  a  case  where  a  corporation  has 
issued  1000  shares  of  stock  of  the  par  value  of  $100  and  distributes 
500  additional  shares  in  payment  of  a  dividend  declared  from  net 
earnings,  profits  or  surplus  amounting  to  $50,000,  an  individual  who 
holds  ten  shares  of  the  original  stock  and  receives  five  shares  of  the 
new  stock  as  his  pro  rata  share  of  the  dividend,  should,  on  account  of 
their  receipt,  include  the  amount  of  $500  in  his  personal  return. 

28.— DIVIDENDS   PAID   IN   SCRIP. 

A  dividend  paid  in  scrip  is  returnable  by  the  shareholder  who 
receives  it  the  same  as  a  cash  dividend,  at  the  amount  at  which  the 
distribution  is  made  by  the  corporation  paying  the  dividend.  Pay- 
ment in  scrip  is  held  to  be  equivalent  to  payment  in  cash,  and  any 
amount  of  interest  subsequently  paid  on  the  scrip  must  be  accounted 
for  as  a  separate  item  of  income. 

29.— DIVIDENDS    FROM    FOREIGN   CORPORATIONS. 

When  a  dividend  is  paid  by  a  fo.eign  corporation  which  derives 
its  entire  income  from  the  business  done  in  the  United  States  and  pays 
a  tax  upon  its  net  income,  such  dividend  is  to  be  treated  in  the  same 
manner  by  its  recipient  as  a  dividend  from  a  domestic  corporation. 


THE    MCOME   TAX  27 

30.— BANK  TAX  A  DIVIDEND. 

When  a  bank  pays  for  its  stockholders  a  tax  assessed  against 
them,  in  proportion  to  their  respective  holdings  of  its  shares,  the 
action  of  the  bank  is  regarded  merely  as  an  accommodation  to  the 
stockholders.  The  amount  of  the  tax  thus  paid  is  allowed  as  a  de- 
duction, not  in  the  return  of  income  filed  by  the  bank,  but  in  the 
returns  filed  by  the  stockholders,  according  to  the  number  of  shares 
held  by  each.  However,  the  individual  stockholder  must  , at  the  same 
time,  regard  the  amount  of  tax  paid  upon  his  shares  as  an  additional 
dividend  and  must  take  the  amount  into  account  in  preparing  his 
return  of  income. 

Banks  generally  notify  their  stockholders  of  the  amount  of 
such  payments.  If  such, notice  is  not  received,  inquiry  should  be  made 
of  the  bank  of  which  the  taxpayer  is  a  stockholder. 

31.— PROFITS   OF   LIMITED   PARTNERSHIP. 

The  profits  of  those  limited  partnerships  which  make  retirns  and 
pay  tax  in  the  same  manner  as  corporations  are  to  be  treated  the  same 
as  dividends  by  individuals  receiving  them.  That  is,  they  should  be 
entered  in  the  individual's  return  as  dividends.  Hence,  they  would 
,not  be  subject  to  the  normal  tax  in  the  hands  of  the  individual  but 
would  enter  into  the  computation  for  the  additional  tax. 

32.— INTEREST. 

Interest  on  notes,  ordinary  mortgages,  and  corporate  obligations, 
is  returnable  as  income  subject  to  tax  for  the  year  in  which  it  is  re- 
ceived, without  regard  to  the  time  of  accrual.  In  the  main  the  re- 
quirement of  the  Treasury  Department  is  only  that  interest  received 
be  returned. 

Interest  on  bank  accounts  should  be  included  in  the  return  for 
the  year  in  which  credited. 

Exceptions  to  the  general  rules,  referred  to  here,  will  be  taken  up 
in  the  discussion  of  other  subjects  as  those  subjects  may  call  for  con- 
sideration of  the  question  of  interest. 

33.— BUSINESS   AND  TRADE. 

The  gross  income  of  every  business  or  trade,  engaged  in  for  gain 
or  p-ofit,  must  be  included  by  the  individual  conducting  it.  Against 
this  gross  income  may  be  entered,  and  from  it  deducted  for  the  pur- 
pose of  the  income  tax,  the  legitimate  expenses  incurred  in  the  con- 
duct of  the  business;  On  this  point  the  language  of  the  statute  is 
•dear.  - 


28  THE   INCOME   TAX 

Just  how  expenses  can  be  deducted  is  explained  in  the  consider- 
ation of  "Deductions,"  and  how  the  income  of  various  kinds  of 
business  should  be  ascertained  in  accordance  with  the  law  and  regula- 
tions is  shown  in  the  specialized  treatment  given  such  subjects. 

34.— SALE  OF  PROPERTY. 

In  the  language  of  the  law  there  must  be  returned  for  tax  the 
income  derived  from  all  "sales,  or  dealings  in  property,  whether  real 
or  personal,  growing  out  of  the  ownership  or  use  of  or  interest  in 
real  or  personal  property.'' 

It  is  the  gain  derived  from  transactions  in  property,  real  or  per- 
sonal, that  is  liable  to  tax — the  gain  derived  from  transactions  fhat 
have  been  completed  with  respect  to  the  particular  property  con- 
cerned, whether  that  property  be  real  estate,  corporate  securities,  or 
property  in  some  other  form. 

The  whole  theory  of  the  administration  of  the  law  is  that  the 
transaction  must  have  been  completed  and  the  gain,  if  any,  must 
have  been  actually  realized.  In  other  words,  the  property  must  have 
been  disposed  of  by  the  taxpayer.  [Likewise  and  conversely  any  loss 
sustained  in  such  a  transaction  must  be  just  as  definite  before  it  can 
be  claimed  as  an  offset  against  income,  but  this  will  be  explained 
under  the  heading  "Losses."] 

The  present  law  provides  an  entirely  new  method  of  ascertaining 
gain  derived  from  the  sale  of  property.  In  respect  to  property  ac- 
quired before  March  1,  1913,  the  incidence  of  the  income  tax,  the 
statute  provides  that  the  fair  market  price  or  value  as  of  March  1, 
1913,  shall  be  taken  as  a  starting  point  or  basis  for  determining  the 
amount  of  gain. 

Under  the  first  law  (Act  of  October  3,  1913)  the  original  cost  price 
(however  far  back)  was  taken  as  the  starting  point,  the  gain  was 
distributed  over  the  years  the  property  was  held  and  the  pro-rata 
belonging  to  the  period  beginning  March  1,  1913,  was  regarded  as 
returnable  income. 

In  the  case  of  sale  or  disposition  of  property  acquired  on  or  after 
March  1,  1913  the  cost  is  taken  as  the  starting  point  and  gain  is  as- 
certained by  determining-  the  difference  between  cost  and  selling 
price. 

It  is  very  important  that  these  two  methods  of  reckoning  gain 
be  kept  distinct  in  the  taxpayer's  mind — that  with  respect  to  property 
acquired  prior  to  March  1,  1913  and  that  with  respect  to  property 
acquired  on  or  after  March  1,  1913.  For  the  former  there  is  the  most 


THE    INCOME   TAX  29 

definite  and  specific  provision  in  the  statute  itself ;  for  the  latter  reg- 
ulations have  been  made  by  the  Treasury  Department. 

35.— GAIN  IN  REAL  PROPERTY. 

With  respect  to  real  estate  the  amendment  of  the  law  has 
worked  important  changes.  When,  under  the  old  provision  it  was 
necessary  in  computing  gain  derived  from  a  sale  of  real  estate  to  go 
back  to  original  cost,  in  all  cases,  and  then  work  out  the  problem  by 
proration,  it  was  impossible  to  ascertain  the  gain  belonging  to  the 
period  covered  by  the  income  tax  law. 

For  instance,  an  individual  may  have  acquired  1000  acres  of  des- 
ert land  in  the  year  1900  for  $20  an  acre.  After  holding  the  land  in 
an  unproductive  state  a  number  of  years,  he  discovered  in  July  1912 
that  it  was  oil-bearing.  Immediately  this  discovery  became  known, 
he  was  offered  $1,000,000  for  the  property.  But  he  did  not  sell  at 
that  time.  Again,  in  January,  1913,  he  was  offered  $1,750,000,  but  he 
held  the  land  until  July  1916  and  then  sold  it  for  $2,000,000. 

Under  the  old  system  of  proration  the  individual's  income  tax 
would  have  been  computed  about  as  follows : 

Selling  price  $2,000,000 

Original  Cost  $20,000 

Carrying  charges  30,000 

(Taxes,  Development,  etc.) 


$50,000 
Total  cost  .  50,000 


Gain  in  16  years $1,950,000 

One  year's  prorata  of  gain  121,875 

Four  years'  pro-rata  487,500 

(1913-1914-1915-1916) 
Subject  to  tax  487,500 

Under  the  new  system  the  computation,  in  the  rough,  would  take 
about  the  following  form  : 

Selling  price  $2,000,000 

Fair  market  value  of  land  as  of  March  1, 
1913,  determined  by  bona  fide  offer  in 
January,  1913  1,750,000 


Gain,  subject  to  tax $250,000 


30  THE  INCOME  TAX 

36.— GAIN  IN  PERSONAL  PROPERTY. 

In  a  similar  way  the  gain  in  a  sale  of  securities,  stocks  or  bonds, 
or  other  form  of  personal  property,  would  be  computed,  according-  to 
the  old  and  the  new  methods. 

Sometimes  the  new  method  made  imperative  by  the  Act  of  Sep- 
tember 8,  1916,  works  in  favor  of  the  taxpayer,  and  at  other  times  in 
favor  of  the  Government. 

In  the  example  just  given,  it  works  in  favor  of  the  taxpayer.  But 
change  the  example.  Suppose,  for  instance,  that  the  individual,  after 
having  received  the  first  offer  of  $1,000,000  for  his  land,  held  it  and 
sold  it  in  July,  1916,  for  $2,000,000 ;  but  did  not,  subsequent  to  July, 
1912,  and  prior  to  March  1,  1913,  receive  a  second  bona  fide  offer. 
In  such  a  case  it  might  have  been  necessary  to  take  the  offer  of 
$1,000,000  in  July,  1912,  as  indicating  with  the  nearest  possible  ap- 
proximation the  fair  market  value  as  of  March  1,  1913,  in  the  absence 
of  other  data  or  the  known  value  of  adjacent  lands  to  the  contrary. 
And,  in  such  circumstances  the  computation  of  gain  would  have 
shown  $1,000,000  instead  of  $250,000. 

37.— FAIR  MARKET  VALUE. 

The  fixing  of  fair  market  price  or  value  as  of  March  1,  1913, 

becomes,  of  necessity,  very  difficult  in  many  instances.  The  govern- 
ment insists  upon  a  conclusive  showing;  and,  likewise,  the  question 
is  of  such  importance  to  the  taxpayer  that  he  should  make  sure  of 
evidence  wrhich  the  Internal  Revenue  officers  must  accept. 

With  respect  to  real  estate,  in  the  absence  of  definite  and  bona 
fide  offers,  the  selling  price  or  market  value  of  adjacent  lands  of 
similar  character  in  regard  to  formation  and  productiveness  is  given 
great  weight.  Also  assessments  made  by  local  officials,  with  due  con- 
sideration for  the  particular  local  percentage  of  assessment,  fre- 
quently help.  And,  in  the  case  of  lands  passing  through  probate  pro- 
ceedings, the  appraisement  of  such  lands  by  the  court  of  jurisdiction. 
All  these  factors,  or  anv  of  them,  can  be  considered.  While  they  are 

••'.I;..!.!'. 

not  invariably  accepted  by  the  Government,  they  do  offer  valuable 
and  generally  acceptable  support  when  it  is  necessary  to  fix  an  arbi- 
trary fair  market  value  as  of  March  1,  1913,  in  the  absence  of  more 
specific  information  regarding  fair  market  price  or  value  as  of  that 
date. 

In  the  matter  of  computing  gain  on  the  sale  of  personal  property, 
such  as  corporate  stock,  acquired  prior  to  March  1.  1913,  very  little 
difficulty  is  experienced  with  respect  to  stocks  listed  on  an  exchange, 


THE    INCOME   TAX  31 

or  quite  generally  dealt  in.  The  varying  daily  market  prices  of  such 
issues  can  be  readily  ascertained.  However,  taking  cognizance  of  the, 
fact  that  in  many  cases  there  is  on  the  one  day  both  an  opening  and 
a  closing  price,  the  Treasury  Department  has  held  that  the  fair  mar- 
ket price  or  value  as  of  March  1,  1913,  is  the  fair  market  price  of 
value  as  of  that  entire  day,  which,  in  the  case  of  variation  between 
an  opening  and  a  closing  price  for  the  day,  would  mean  the  average 
price  for  the  day.  Even  this,  however,  would  be  conditioned  upon 
showing  that  the  exchange  quotation  actually  represented  the  fair 
market  price  or  value  of  the  stock. 

In  the  case  of  securities  that  are  not  commonly  or  frequently 
dealt  in,  great  difficulty  is  experienced  in  ascertaining  fair  market 
price  or  value  as  of  March  1,  1913.  The  Treasury  Department  has 
not  laid  down  a -rule  that  can  be  invariably  followed,  and  the  result 
is  that  each  case  must  be  considered  by  itself  according  to  the  data 
available.  Private  sales  of  such  securities,  or  the  market  price  of 
other  securities  with  assets  of  about  the  same  value  and  productive- 
ness back  of  them,  or  appraisal  by  a  court,  can  be  taken  into  con- 
sideration, even  though  not  always  controlling.  Thus,  at  best,  in 
many  cases,  the  computation  becomes  an  approximation. 

38.— SALE  OF  SECURITIES  LEFT  BY  DECEDENT. 

In  this  connection  an  interesting  point  arises  with  respect  to  the 
sale  of  inherited  securities  by  a  beneficiary  under  a  wrill. 

If,  for  instance,  a  beneficiary  under  a  will  receives  certain  secur- 
ities which  have  been  appraised  as  of  date  of  the  decedent's  death, 
at  $100  a  share,  and  subsequently  sells  them  at  $125  a  share,  he  must 
include  the  increase  in  value  in  his  return  of  income.  In  this  con- 
nection it  is  essential  that  the  taxpayer  not  confuse  the  increase  of 
value  after  the  securities  have  come  into  the  possession  of  the  bene- 
ficiary with  the  value  of  them  at  the  time  of  the  inheritance.  The 
latter  value,  fixed  by  appraisal,  in  this  example,  at  $100  a  share,  rep- 
resents the  inheritance  proper  and,  as  such,  is  not  subject  to  income 
tax  ;  but  the  gain,  amounting  to  $25  a  share,  is  a  profit  derived  by  the 
beneficiary  from  property  received  by  inheritance  and  is,  therefore, 
income  which  must  be  returned  for  tax  by  him.  In  other  words  the 
gain  realized  after  the  securities  have  come  into  the  possession  of 
the  beneficiary  is  not  a  part  of  the  inheritance. 

39.— SECURITIES   SOLD   BY   ESTATE. 

If  securities  belonging  to  an  estate  are  sold  prior  to  the  settle- 
ment of  the  estate  by  the  executors  or  administrators,  any  gain  de- 


32  THE   INCOME   TAX 

rived,  if  any,  is  computed  exactly  as  in  the  case  of  an  individual,  is 
considered  income  accruing  to  the  estate  and  is,  therefore,  subject  to 
tax. 

40.— IDENTITY  OF   STOCK  UNCERTAIN. 

When  various  parcels  of  stock  of  the  same  issue  are  bought  and 
sold  at  different  dates  the  rule  is  that  wherever  possible,  the  shares 
sold  shall  be  identified  by  the  numbers  of  the  certificates  covering 
them.  When  stock  is  sold,  and  its  identity  cannot  be  determined,  the 
Government  requires  that  it  be  charged  against  the  stock  first  pur- 
chased. If  the  purchase  occurred  on  or  after  March  1,  1913,  the  entire 
amount  of  difference  should  be  returned  for  tax. 

41.— GAIN  FROM  SALE  OF  RIGHTS. 

In  the  enforcement  of  the  law  there  have  arisen  many  unusual 
cases  of  income  to  be  classified  and  defined.  One  of  these  is  that 
accruing  to  an  individual  who  holds  stock  in  a  corporation  by  reason 
of  the  sale  of  his  rights  to  subscribe  to  new  stock  in  the  corporation. 
Basing  its  ruling  upon  the  requirement  of  the  law  that  income  from 
all  sources  be  returned  for  tax,  the  Treasury  Department  has  held 
that  such  income  must  be  included  in  the  individual's  return. 

42.— ACCIDENT  INSURANCE. 

Accident  insurance  gives  rise  to  another  form  of  income.  Money 
received  by  the  person  insured  by  an  accident  policy  on  account  of  an 
accident  sustained  is  taxable  income  and  must  be  returned  by  the  in- 
sured person.  However,  upon  the  death  of  the  person  insured,  when 
the  proceeds  of  the.  policy  are  paid  to  the  individual  beneficiary  named 
in  the  policy,  the  amount  paid  is  treated  like  the  proceeds  of  a  life  in- 
surance policy  and  is  not  subject  to  tax. 

43.— DAMAGES. 

And,  likewise,  any  amount  received  as  "damages"  or  compensa- 
tion for  injury  or  suffering,  as  the  result  of  a  suit  or  other  proceeding, 
is  income  returnable  by  the  person  receiving  the  payment.  However, 
should  the  amount  received  be  in  the  form  of  reimbursement  for  ex- 
penses incurred  by  the  recipient  as  the  result  of  an  accident,  it  is  not 
subject  to  tax. 

44.— ALIMONY  AND  SEPARATE  MAINTENANCE. 

An  amount  paid  as  alimony  or  for  separate  maintenance  is  tax- 
able income  to  the  person  receiving  it.  The  woman  must  include 


THE    INCOME   TAX  33 

the  amount  in  her  return  if  she  has  sufficient  income,  including  the 
amount  received,  to  make  her  liable  to  file  a  return.  On  the  other 
hand,  however,  such  a  payment  is  regarded  as  a  personal  expenditure 
on  the  part  of  the  man  paying  it  and,  as  such,  is  not  allowable  as  a 
deduction  in  his  return. 

45.— FARMER'S   INCOME. 

By  reason  of  the  fact  that,  generally  speaking,  he  does  not  keep 
his  accounts  in  very  good  order,  the  farmer  has  trouble  ascertaining 
his  income  tax  liability.  Some  simple  form  of  accounting  should  be 
instituted  by  every  farmer.  It  need  not  be  elaborate  even  though 
his  business  be  quite  extensive.  But  some  system  is  one  of  his  most 
urgent  needs  if  he  is  to  be  prepared  to  take  advantage  in  full  of  those 
deductions  to  which  the  law  says  he  is  entitled. 

Without  a  system  of  accounting,  the  farmer  finds  himself  at  the 
end  of  the  year  with  practically  nothing  but  the  stubs  of  his  check- 
book to  help  him  meet  the  perplexing  requirements  of  the  income 
tax  law.  And  the  inevitable  result  is  that  he  has  lost  track  of  in- 
numerable expenditures  that  would  be  allowable  as  deductions  could 
he  state  them  in  detail.  Moreover,  he  is  in  no  position  to  take  ac- 
count of  the  depreciation  of  his  equipment,  an  item  which,  in  many 
another  business,  is  most  carefully  guarded.  In  brief,  the  farmer  not 
only  cannot  state  his  gross  income  for  the  year  correctly,  but  is  also 
unable  to  claim  the  rights  to  which  he  is  entitled. 

As  in  the  case  of  any  other  business,  that  of  the  farmer  also  re- 
quires individual  consideration  with  respect  to  this  preparation  of  his 
return  of  income.  The  Treasury  Department  has,  however,  laid  down 
several  general  rules  of  guidance  which  are  outlined  here. 

46.— INCOME  WHEN  PRODUCTS  ARE  SOLD. 

All  income  derived  from  the  sale  or  exchange  of  farm  products 
should  be  included  in  the  return  of  income  for  the  year  in  which  the 
products  are  actually  marketed  and  sold.  This  rule  covers  not  only 
that  which  is  produced  by  the  farmer  making  the  return  on  his  own 
place,  but  also  any  other  farm  products  which  are  purchased  and  re- 
sold by  him. 

For  example  :  The  returns  from  hay,  cut  in  the  spring  of  1917 
but  held  by  the  farmer  in  stack  or  warehouse  until  the  year  1918  for 
sale,  belong  to  the  farmer's  income  for  1918.  Grain,  harvested  in 
the  summer  of  1917  but  held  for  sale  until  the  spring  of  1918,  con- 


34  THE   INCOME   TAX 

tributes  to  the  farmer's  income  for  1918.  And  the  same  with  all 
other  products  that  can  be  held  for  marketing  with  the  prospect  of 
or  hope  for  more  favorable  prices. 

47.— RENTS  IN  CROP  SHARES. 

Likewise,  rents  received  in  crop-shares  are  to  be  included  in  the 
return  of  income  for  the  year  in  which  such  crop-shares  are  reduced 
to  money  or  a  money  equivalent. 

For  example :  A  entered  into  a  contract  with  B  by  the  terms  of 
which  B  agreed  to  produce  during  the  year  1915  a  crop  of  barley  on 
A's  land  and  deliver  to  A  a  third  of  the  barley  in  sack,  as  rent.  B 
sold  his  two-thirds  share  of  the  barley  immediately  after  harvest ;  A 
held  his  one-third  share  until  the  following  spring  and  then  sold  it. 
B  should  have  returned  the  proceeds  of  his  share  as  income  for  the 
year  1915  and  A  the  proceeds  of  his  share  as  income  for  the  year 
1916,  notwithstanding  that  the  barley  was  all  produced  at  the  same 
time. 

48.— COST  OF  CROPS. 

But,  while  the  proceeds  from  the  sale  of  farm  products  should 
be  included  in  the  return  of  income  for  the  year  in  which  sold,  the 
cost  of  production  is  allowable  as  a  deduction  for  expense  in  the  re- 
turn for  the  year  in  which  incurred.  In  other  words,  the  cost  of 
operating  a  farm  during  the  year  1917  should  be  deducted  as  expense 
in  the  return  for  1917,  even  though  the  crop  produced  is  held  for  sale 
beyond  the  end  of  the  year  1917. 

49.— COST  OF  LIVESTOCK. 

When  livestock  is  purchased  for  resale  by  a  farmer,  its  cost  is  an 
allowable  deduction  as  an  item  of  expense  of  operation ;  but  when 
livestock  is  purchased  for  breeding  or  working  purposes,  the  cost  is 
not  an  allowable  deduction  as  an  expense  in  the  farmer's  return  of  in- 
come. In  the  latter  case  the  expenditure  is  regarded  as  an  investment 
of  capital.  . 

For  example  :  A  buys  a  number  of  calves  and  steers  to  feed  and 
fatten  for  market,  and  the  cost  of  the  stock  can  be  deducted  by  him 
as  an  item  of  expense.  But  when  A  buys  a  number  of  cows  and 
mares  for  breeding  purposes,  and  a  work  team  of  mules,  his  expendi- 
ture for  them  cannot  be  deducted  in  his  return. 

50.— LOSS  OF  LIVESTOCK. 

A\  here  livestock  has  been  purchased  by  the  farmer  for  any  pur- 
pose and  later  dies  from  disease  or  injury,  or  is  killed  by  order  of 


THE    INCOME   TAX  35 

public  authorities,  the  cost  can  be  deducted  as  a  loss  by  the  farmer  in 
his  return  of  income,  provided  (in  the  case  of  animals  purchased  for 
marketing)  the  cost  has  not  already  been  deducted  as  an  item  of  ex- 
pense, and  less  (in  the  case  of  animals  purchased  for  breeding  and 
working  purposes)  any  amount  claimed  as  a  deduction  on  account  of 
depreciation. 

If  a  fanner,  who  has  deducted  as  a  loss  the  cost  of  animals  killed 
by  order  of  public  authorities,  is  later  reimbursed  by  the  State,  or  the 
United  States,  in  whole  or  in  part,  on  account  of  stock  killed,  he  is 
required  to  report  the  amount  of  such  reimbursement  as  income  for 
the  year  in  which  received.  The  same  rule  also  holds  true  with  re- 
spect to  reimbursement  for  other  property  destroyed,  when  deduc- 
tion has  been  claimed  as  a  loss  on  account  of  such  destruction. 

51.— COST  OF  FARM  EQUIPMENT. 

The  cost  of  farm  machinery  is  not  an  allowable  deduction  as  an 
item  of  expense.  Such  an  expenditure  is  regarded  as  a  capital  invest- 
ment. 

However,  the  cost  of  the  ordinary  tools  used  on  the  farm  is  re- 
garded as  an  item  of  expense  and  may  be  so  deducted. 

By  farm  machinery  is  meant  such  equipment  as  wagons,  harvest- 
ers, mowers,  tractors,  and  the  like. 

By  farm  tools  are  meant  articles  such  as  axes,  she  vels,  simple 
plows  and  harrows  and  similar  equipment. 

52.— DEPRECIATION  ON  THE  FARM. 

The  farmer  may  in  his  return  of  income,  also  claim  as  a  deduction 
on  account  of  the  exhaustion,  wear  and  tear  of  his  property,  arising 
out  of  its  use  in  his  business,  a  reasonable  allowance  for  depreciation. 

This  applies  to  farm  buildings  (other  than  a  dwelling  on  the  farm 
occupied  by  the  owner).  It  can  be  claimed  on  all  buildings  and 
structures  used  in  connection  with  the  business  of  farming — barns, 
sheds,  fences,  drying-sheds,  quarters  of  employees  and  the  like. 

It  applies  also  to  farm  machinery  and  to  livestock  purchased  for 
breeding  and  working  purposes. 

It  does  not  apply  to  livestock  purchased  for  resale,  the  cost  of 
which  can  be  deducted  as  an  item  of  expense. 

53.— EXCEPTIONS  TO  GENERAL  RULES. 

In  general,  the  rules,  given  above  are  to  be  followed  by  the 
farmer.  However,  there  is  a  provision  in  the  Income  Tax  law  ( Sub- 
division G  of  Section  8)  which  allows  an  individual  keeping  accounts 


36  THE   INCOME   TAX 

upon  any  basis  other  than  that  of  actual  receipts  and  disbursements 
to  make  his  return  upon  the  basis  upon  which  his  accounts  are  kept, 
provided  his  method  reflects  his  income.  Hence,  the  farmer,  who 
keeps  books,  according  to  some  approved  method  of  accounting, 
which  clearly  show  his  net  income  for  the  year,  may  prepare  his  re- 
turn from  his  books,  even  though  his  system  may  not  follow  strictly 
the  rules  outlined  hereinbefore. 

In  the  event,  however,  that  a  farmer  departs  from  the  rules  and 
follows  his  own  system,  he  must  have  his  accounts  in  condition  for 
examination  by  field  officers  of  the  Internal  Revenue  Service. 

54.— FARMING  FOR  FUN. 

The  rules  hereinbefore  explained  are  applicable  to  farming  as  a 
business,  for  profit.  A  person  who  cultivates  a  farm  for  recreation 
or  pleasure,  and  not  according  to  the  principles  of  commercial  farm- 
ing, is  not  regarded  as  a  "farmer."  The  result,  in  his  case,  is  gen- 
erally a  loss  from  year  to  year,  and,  if  the  expenses  of  cultivation 
are  in  excess  of  the  receipts  from  the  farm,  the  entire  venture  may 
be  ignored  in  the  preparation  of  his  return  of  income.  The  receipts 
need  not  be  included  in  his  return  and  the  expenses  of  cultivation, 
being  regarded  as  personal  expenditures  for  pleasure,  cannot  be  de- 
ducted from  income  derived  from  other  sources. 

55.— INCOME  DERIVED  FROM  GIFT. 

While  the  law  provides  that  "the  value  of  property  acquired  by 
gift,  bequest,  devise,  or  descent,"  is  not  income  subject  to  tax,  it  must 
be  clearly  understood  that  any  gains  or  profits  derived  from  such 
property,  after  the  property  has  been  thus  acquired,  are  subject  to 
tax.  For  example :  A  inherits  industrial  bonds  valued  at  $100,000 
paying  interest  at  the  rate  of  6  per  cent  per  annum.  The  value  of 
the  bonds  is  not  taxable  income  to  A  but  the  interest  received  by  A 
after  his  acquisition  of  the  bonds  must  be  returned  by  him. 

56.— PENSIONS. 

Pensions  paid  by  the  United  States  Government  are  subject  to 
the  income  tax. 

Likewise  pensions  paid,  by  private  corporations  to  retired  em- 
ployees are  subject  to  tax  if  the  person  receiving  them  has  sufficient 
income,  including  the  amount  thus  received,  to  make  him  liable. 

57.— INCOME  FROM  PARTNERSHIP. 

While  a  partnership  is  not  subject  to  income  tax,  each  individual 
partner  is  required  to  include  in  his  personal  return  as  a  part  of  his 


THE    INCOME   TAX  37 

gross  income  his  share  of  the  net  earnings  of  the  partnership.  How- 
ever, the  members  of  a  partnership  which  deals  in  State,  municipal  or 
other  similar  bonds,  the  interest  on  which  is  not  subject  to  income 
tax,  can  exclude  from  their  distributive  interests  in  the  partnership's 
earnings  their  proportionate  shares  of  the  interest  received  by  the 
partnership  on  all  such  bonds. 

58.— INCOME  FROM  EXPORT  BUSINESS. 

It  has  now  been  determined  that  income  derived  from  an  export 
business  is  clearly  subject  to  tax.  Legal  attack  was  made  on  the  re- 
quirement that  income  from  such  business  be  returned  for  taxation, 
the  contention  being  that  such  an  interpretation  of  the  law  was  un- 
constitutional on  the  ground  that  to  tax  the  income  from  export  busi- 
ness is  to  tax  the  articles  exported.  In  the  case  of  Wm.  E.  Peck  & 
Co.  vs.  John  Z.  Lowe  Jr.,  collector  (234  Fed.  125)  decision  is  given  in 
favor  of  the  Government,  and  the  income  from  such  business  is  sub- 
ject to  tax. 

59.— ROYALTIES,  PATENTS,  COPYRIGHTS. 

A  payment  in  the  form  of  a  royalty  on  a  patent  is  returnable  by 
its  recipient. 

A  payment  in  absolute  purchase  of  a  patent  right,  as  a  result  of 
which  title  to  the  patent  passes,  is  returnable  by  the  recipient  as  in- 
come to  the  amount  by  which  such  payment  exceeds  the  aggregate 
amount  expended  in  perfecting  the  invention  and  obtaining  the  patent. 

Quite  similarly  would  be  treated  income  derived  in  the  form  of 
royalties  on  publications  or  from  the  disposition  of  a  copyright. 

The  consideration  of  royalties  from  mines  and  oil  and  gas  wells 
will  be  taken  up  in  connection  with  the  treatment  of  income  from 
natural  deposits  in  the  earth. 

60.— MATURED  BUILDING  AND  LOAN  SHARES. 

When  a  certificate  in  a  Building  and  Loan  Association  is  ma- 
tured and  payment  on  account  of  such  maturity  is  made  by  the  asso- 
ciation to  the  holder  of  the  certificate,  if  the  amount  paid  is  in  excess 
of  the  aggregate  of  the  deposits  made  by  the  holder  of  the  certificate 
to  bring  the  certificate  to  maturity,  the  amount  of  such  excess  should 
be  returned  by  the  certificate  holder  for  the  year  during  which  the 
certificate  is  matured. 

61.— TAXABLE  INSURANCE  INCOME. 

While  the  law  exempts  from  tax  the  proceeds  of  life  insurance 
policies  paid  to  individual  beneficiaries  upon  the  death  of  the  insured, 


38  THE   INCOME   TAX 

and  the  amount  received  by  the  insured,  as  a  return  of  premiums  paid 
by  him  under  a  life  insurance  endowment,  or  annuity  contract,  either 
during  the  term  or  at  the  maturity  of  the  term  mentioned  in  the  con- 
tract or  upon  the  surrender  of  the  contract,  still  there  are  certain 
gains  from  insurance  policies  or  contracts  that  are  regarded  as  tax- 
able income. 

When  the  amount  paid  to  the  insured  under  a  life  insurance,  en- 
dowment, or  annuity  contract,  either  upon  the  maturity  or  surrender 
of  the  contract,  exceeds  the  sum  paid  by  the  insured  pursuant  to  the 
contract,  the  amount  of  the  excess  is  held  to  be  income  subject  to  tax 
and  should  be  returned  by  its  recipient. 

Also  dividends  received  by  the  insured  from  a  paid-up  policy  are 
held  taxable  income  to  the  insured  and  must  be  treated  the  same  as 
dividends  from  a  corporation's  earnings  in  his  individual  return  of 
income. 


THE   INCOME   TAX  39 


CHAPTER  V 


THE  INCOME  TAX 


INCOME  EXEMPT  FROM  TAX 


Under  the  specific  mandate  of  the  statute  certain  income  is  ex- 
empt from  the  provisions  of  the  law.  Such  income  is  clearly  defined 
and  is  exempt  not  only  from  tax  but  also  from  any  other  provision 
of  the  law.  In  other  words,  with  respect  to  income  which  comes 
within  the  exemptions  named  in  the  statute,  the  recipient  has  no  duty 
to  perform  to  the  Government.  He  is  not  even  required  to  report 
any  such  income  and  no  amount,  thus  received,  need  be  considered  by 
him  in  determining  his  liability  to  make  a  return. 

62.— DEFINITION  OF  EXEMPT  INCOME. 

Section  4  of  the  Income  Tax  Law,  Act  of  Sept.  8,  1916,  peads  as 
follows : 

The  following  income  shall  be  exempt  from  the  pro- 
visions of  this  title: 

The  proceeds  of  life  insurance  policies  paid  to  individual 
beneficiaries  upon  the  death  of  the  insured; 

The  amount  received  by  the  insured,  as  a  return  of  pre- 
mium or  premiums  paid  by  him  under  life  insurance,  endow- 
ment or  annuity  contracts,  either  during  the  term  or  at  the 
maturity  of  the  term  mentioned  in  the  contract  or  upon  sur- 
render of  the  contract; 

The  value  of  property  acquired  by  gift,  bequest,  devise 
or  descent  (but  the  income  from  such  property  shall  be  in- 
cluded as  income)  ; 

Interest  upon  the  obligations  of  a  State  or  any  political 
subdivision  thereof  or  upon  the  obligations  of  the  United 
States  (but,  in  the  case  of  obligations  of  the  United  States 


40  THE   INCOME   TAX 

issued  after  September  1,  1917,  only  if  and  to  the  extent 
provided  in  connection  with  the  issue  thereof)  or  its  pos- 
sessions or  securities  issued  under  the  provisions  of  the  Fed- 
eral Farm  Loan  Act  of  July  17,  1916; 

The  compensation  of  the  present  President  of  the  United 
States  during  the  term  for  which  he  has  been  elected  and  the 
judges  of  the  supreme  and  inferior  courts  of  the  United 
States  now  in  office, 

And  the  compensation  of  all  officers  and  employees  of  a 
State,  or  any  political  subdivision  thereof,  except  when  such 
compensation  is  paid  by  the  United  States  Government. 

63.— PROCEEDS  OF  INSURANCE  POLICIES. 

In  making  up  his  return  of  income  the  taxpayer  can  ignore 
income  derived  from  insurance  policies  or  contracts  as  such  income 
comes  within  the  meaning  of  the  law.  He  should  not  include  any 
amount  thus  received  in  his  statement  of  gross  income.  He  can  be 
guided  by  the  following  general  definitions  of  exempt  insurance  in- 
come : 

(a)  Proceeds   of   life   insurance   policies   paid   upon   the 
death  of  the  person  insured  to  an  individual  beneficiary. 

(b)  Amount  paid  under  a  life  insurance,  endowment,  or 
annuity  contract  to  the  person  making  the  contract  (the  in- 
sured) either  upon  the  maturity  or  surrender  of  the  contract ; 
provided,  such  payment  does  not  exceed  the  sum  paid  on  the 
contract  by  the  insured.    When  there  is  such  an  excess,  the 
amount  of  it  becomes  taxable  income  in  the  hands  of  its  re- 
cipient, the  insured. 

(c)  Dividends  paid  on  life  insurance  policies  that  have 
not  matured,  whether  such  dividends  are  drawn  in  cash  by 
the  insured  or  applied  to  the  reduction  of  the  annual  premium 
due.      (Dividends   from  paid-up  policies  are,   however,   con- 
sidered taxable  income.) 

(d)  Amount  paid  on  life  insurance  policy  to  beneficiary 
in  annuities  or  installments. 

64.— GIFTS,  BEQUEST,  ETC. 

The  law  provides  that  the  value  of  property  acquired  by  gift,  be- 
quest, devise,  or  descent  does  not  represent  taxable  income  to  the 
recipient,  but  it  does  definitely  provide  that  any  income  from  such 
property,  after  the  property  has  come  into  the  hands  of  the  recipient, 
is  taxable  and  must  be  returned  by  him. 


THE   INCOME   TAX  41 

Distinction  must  therefore,  be  drawn  between  the  value  of  the 
property  at  the  time  it  comes  into  the  possession  of  the  person  who 
benefits  by  the  gift  or  bequest,  and  the  subsequent  income  from  the 
property. 

A  bonus  received  by  an  employee,  as  additional  compensation  for 
services  rendered,  is  not  a  gift,  if  paid  by  the  employer  pursuant  to  a 
contract,  express  or  implied,  or  pursuant  to  a  fixed  policy  or  practice. 
In  such  circumstances,  the  amount  of  the  bonus  is  regarded  as  a  part 
of  the  wage  of  the  employee.  Payment  of  the  bonus  in  a  case  of 
this  kind,  however,  would  have  to  be  conditioned  upon  the  services 
rendered  by  the  employee  and  not  upon  the  earnings  of  the  employer. 

Where  the  salary  of  an  employee  is  paid  for  a  limited  period 
after  his  death  to  his  widow,  or  other  dependents,  in  recognition  of 
the  services  rendered  by  the  deceased  employee,  no  services  being 
rendered  by  the  widow  or  other  dependents,  the  payment  is  regarded 
as  a  gift  and  is  not  subject  to  tax. 

65.— INTEREST  ON  U.  S.  AND  STATE  BONDS. 

Income  in  the  form  of  interest  on  bonds  or  obligations  of  the 
following  general  classifications  is  exempt  and  need  not  be  included 
in  a  return : 

(a)  Bonds   or   obligations   of   the   United   States   or   its 
possessions  (except  as  to  the  limitation  with  respect  to  ob- 
ligations issued  after  September  1,   1917,  as  hereinafter  ex- 
plained). 

(b)  Federal  Farm  Loan  bonds,  issued  under  authority  of 
the  Federal  Farm  Loan  Act  of  July  17,  1916. 

(c)  Bonds  of  any  State. 

(d)  Bonds  of  any  political  subdivision  of  a  State. 

[Note — important : 

The  exception  noted  above  in  (a),  with  respect  to  interest  on 
bonds  or  obligations  of  the  United  States  issued  after  September  1, 
1917,  has  reference  to  a  provision  in  the  Act  of  September  24,  1917  to 
the  effect  that  if  the  aggregate  principal  of  the  bonds  and  certificates 
issued  by  its  authority  and  owned  by  one  individual,  partnership,  cor- 
poration or  association,  does  not  exceed  $5,000,  the  interest  on  them 
is  exempt  from  income  tax.  If  the  aggregate  principal  of  a  single 
holding  does  exceed  $5,000,  then  the  interest  on  the  principal  in  excess 
of  $5,000  is  subject  to  the  graduated  additional  income  tax.  But  only 
an  individual  is  liable  to  the  graduated  additional  income  tax ;  hence 
only  an  individual  is  concerned  with  the  amount  of  investment  in  such 


42  THE   INCOME   TAX 

securities  when  income  tax  liability  with  respect  to  the  interest  is 
incurred.  The  Liberty  Loan  Bonds  of  the  Second  Series  were  issued 
subject  to  this  provision.  The  Liberty  Loan  Bonds  of  the  First  Series 
are  not  subject  to  the  provision,  they  having  been  issued  prior  to  Sep- 
tember 1,  1917.  All  interest  on  the  bonds  of  the  First  Series  is  exempt 
from  income  tax.] 

66.— WHAT  "POLITICAL  SUBDIVISION"  COVERS. 

Referring  to  sub-paragraph  (d)  of  the  preceding  general  para- 
graph, the  full  scope  of  the  meaning  of  the  phrase  "political  sub- 
division of  a  state"  should  be  understood.  The  Treasury  Department 
has  ruled,  upon  the  advice  of  the  Attorney-General  of  the  United 
States,  that  it  comprehends  the  bonds  issued  by 

(a)  Municipalities 

(b)  Counties 

(c)  School  Districts 

(d)  Irrigation  Districts 

(e)  Reclamation  Districts 

(f)  Levee  Districts 

(g)  Street  Assessment  Districts. 

Interest  on  all  such  bonds  is  not  to  be  considered  for  income-tax 
purposes. 

However,  a  mortgage  assumed  by  a  municipality  in  the  purchase 
of  a  public  utility,  at  the  time  of  purchase  subject  to  mortgage,  does 
not  become  an  obligation  of  the  municipality  within  the  meaning  of 
the  exempting  provisions  of  the  law  with  respect  to  interest. 

67.— STATE,  COUNTY,  MUNICIPAL  EMPLOYEES. 

The  exemption  with  respect  to  the  compensation  of  officers  and 
employees  of  a  State,  or  political  subdivison  of  a  State  is  applicable 
to  the  salaries  not  only  of  all  elected  and  appointed  officers  and  em- 
ployees of  a  State,  county  or  municipality  but  also  to  the  salaries  of 
public-school  teachers,  members  of  the  faculty  and  employees  of  a 
State  University  or  other  institution  of  learning,  managers,  super- 
intendents and  employees  of  all  State,  county  and  municipal  institu- 
tions, and  even  special  compensation  paid  by  a  State,  or  any  political 
subdivision  of  a  State,  for  professional  services,  whether  such  pay- 
ment be  denominated  salary  or  special  fee. 

However,  a  payment  made  by  a  State  or  political  subdivision  of  a 
State  to  a  contractor  engaged  in  the  construction  of  a  public  work 
pursuant  to  the  terms  of  a  contract  is  not  exempt. 


THE   INCOME  TAX  43 


CHAPTER  VI 


THE  INCOME  TAX 

DEDUCTIONS   ALLOWED   INDIVIDUALS 


[The  deductions  explained  in  this  chapter  are  those  allowed  citizens 

or    residents.      For    deductions    allowed    non-resident    aliens    read 

chapter  on  "Non-Resident  Aliens."] 

Unless  the  individual,  on  the  one  hand,  knows  his  rights  of  de- 
duction and,  on  the  other,  understands  the  technical  limitations  es- 
tablished by  the  Treasury  Department,  he  is  sure  to  be  in  trouble  all 
the  time,  both  before  and  after  the  filing  of  his  return.  He  may,  in  the 
first  place,  overestimate  his  rights,  upon  the  meager  information  avail- 
able to  him,  and  decide,  without  consulting  authority,  not  to  file  a 
return.  Then  comes  a  day  of  reckoning.  The  field  officers  of  the 
Internal  Revenue  Service,  following  leads  from  their  innumerable 
sources  of  information,  check  him  up  and  call  for  an  explanation. 

Or,  the  individual  may,  in  an  excess  of  caution,  neglect  to  charge 
against  his  gross  income  for  the  year  deductions  to  which  he  is  legit- 
imately entitled.  He  may  be  wary  of  insisting  upon  the  credits  the 
law  allows  him  lest  he  make  a  mistake.  Government  officers  do  not, 
as  a  rule,  call  him  in  and  advise  him  that  he  has  overstated  his  tax- 
able income.  In  haphazard  fashion  he  makes  up  his  return  and  sub- 
mits thousands  of  dollars  to  assessment  that  the  law  does  not  con- 
template taxing.  He  pays  dearly  for  his  failure  to  assert  his  rights. 

It,  therefore,  behooves  every  individual  to  look  closely  into  his 
rights  of  deduction  before  filing  his  return.  In  this  chapter  such 
rights  of  deduction  will  be  outlined.  It  will  be  necessary,  however, 
to  supplement  the  information  given  in  this  chapter  by  consulting 
that  given  elsewhere  in  the  book  under  headings  applicable  to  the 
questions  involved. 


44  THE   INCOME  TAX 

68.— EXPENSE  OF  BUSINESS. 

The  deduction  for  expense  is  limited  to  the  expenditures  in  the 
conduct  of  the  business  of  the  individual  during  the  year  for  which 
the  return  is  made.  There  may  be  one  business,  or  more  than  one ; 
if  the  necessary  expense  of  operation  for  the  year  has  actually  been 
paid,  the  amount  may  be  deducted.  This  expense  may  comprise  many 
items,  as  will  hereinafter  be  explained,  but  the  first  essential  is  that 
it  be  strictly  the  year's  operating  expenditure  in  connection  with  the 
individual's  business. 

69.— NO  PERSONAL  EXPENSE. 

No  amount  representing  the  personal,  living  or  family  expenses 
of  the  taxpayer  can  be  deducted  in  his  return.  On  this  point  the  Gov- 
ernment is  very  strict  and  a  great  deal  of  the  trouble  in  which  tax- 
payers have  become  involved  has  been  due  to  their  failure  to  obey  the 
requirement,  generally  through  lack  of  understanding  of  some  of  the 
Government's  finely  drawn  distinctions  between  business  and  per- 
sonal expense.  However,  with  respect  to  the  general  exclusion  of 
personal,  living  or  family  expenses  the  language  of  the  law  is  clear, 
even  though  individuals  may  differ  regarding  the  distinctions  im- 
posed by  regulations  and  decisions. 

70.— NO  PARTNERSHIP  EXPENSE. 

A  business  expense  incurred  by  a  partnership  is  not  allowable  as 
a  deduction  in  the  return  of  an  individual  partner  for  the  reason  that 
such  partner  is  required  in  his  statement  of  gross  income  from  all 
sources  to  include  only  his  share  of  the  net  earnings  of  the  partner- 
ship. The  business  expenses  of  the  partnership  have,  therefore,  been 
taken  care  of  in  determining  the  partnership's  net  earnings,  and  are 
not  a  proper  charge  against  the  gross  income  of  the  individual  partner. 

71.— NO  COST  OF  MERCHANDISE. 

Cost  of  merchandise,  when  considered  in  connection  with  a  mer- 
cantile business,  should  not  be  deducted  as  an  item  of  expense.  Gross 
income  from  a  mercantile  business — the  amount  reported  in  the  re- 
turn— is  ascertained  by  opening  and  closing  inventories,  hence  cost  of 
merchandise  is  accounted  for  in  ascertaining  the  amount  of  gross  in- 
come from  the  mercantile  business  and  would  not,  therefore,  be 
properly  chargeable  again  in  the  individual's  return. 

72.— NO   PERMANENT   IMPROVEMENT. 

And  a  question  that  has  given  rise  to  no  end  of  controversy  is 
that  relative  to  expenditures  for  improvements  and  betterments.  The 


THE   INCOME   TAX  45 

law  and  Treasury  Department  regulations  do  not  allow  such  an  ex- 
penditure as  a  deduction  from  gross  income.  An  expense  of  this  na- 
ture is  regarded  as  a  capital  investment.  In  many  instances,  how- 
ever, it  has  been  difficult  to  draw  the  line  between  business  expense 
amd  expenditure  for  a  permanent  improvement  or  betterment.  So 
many  and  varied  problems  have  arisen  that  each  case  must  be  con- 
sidered upon  its  own  merits.  Always,  however,  the  theory  should  be 
followed  that  an  expense  tending  to  increase  the  value  of  a  property 
goes  into  an  improvement  or  betterment,  and  is  not  deductible.  Such 
would  be  the  cost  of  new  buildings,  or  of  additions  to  old  buildings, 
and  the  remodeling  of  old  buildings  and  installation  of  modern  equip- 
ment and  conveniences.  In  this  last  respect,  however,  the  cost  of  re 
pairing  and  rennovating  a  business  building,  as  such  expenditure  is 
necessary  to  keep  the  building  a  producing  property,  is  an  allowable 
deduction  as  a  business  expense. 

Other  paragraphs  on  special  subjects  should  be  consulted  for  in- 
formation as  to  the  treatment  of  expenses  in  connection  with  them. 

73.— EXPENSES  ON  RENTED  PROPERTY. 

In  his  return  the  individual  is  required  to  report  his  gross  re- 
ceipts from  rents.  Deduction  may  be  claimed  on  account  of  any  ex- 
pense incurred  in  the  maintenance  of  the  property,  or  its  use,  for 
rental  purposes,  including  amounts  paid  for  repairs,  insurance,  fuel, 
light  and  water,  janitor  and  elevator  service.  The  deduction  for  such 
expense  of  maintenance  must,  however,  be  claimed  against  total  gross 
income  from  all  sources.  Experience  has  shown  that  many  landlords 
have  first  deducted  from  gross  rental  receipts  the  expense  of  main- 
tenance and  have  then  included  in  their  returns  the  net  income  from 
rent.  This  is  not  allowed  under  the  regulations  of  the  Treasury  De- 
partment. 

74.— ASSESSMENTS  ON  STOCK. 

Assessments  paid  by  an  individual  on  stock  do  not  constitute  a 
deductible  expense  any  more  than  does  an  original  investment  in 
stock.  Such  payments  are  regarded  as  strictly  capital  transactions — 
as  additional  investments  of  capital  in  the  stock  of  the  corporation. 

In  New  York  City  there  arose  an  interesting  case  in  this  connec- 
tion. A  corporation,  whose  stock  had  been  fully  paid  and  was  non- 
assessable, found  a  deficit  at  the  close  of  the  year,  which  the  stock- 
holders made  good  by  agreeing  to  the  payment  of  voluntary  assess- 
ments. The  Treasury  Department  held,  by  letter,  that  the  payment 


46  THE   INCOME   TAX 

of  such  "voluntary  assessment"  by  the  stockholders  was,  to  all  in- 
tents and  purposes,  additional  payment  for  the  stock  of  the  corpora- 
tion and,  therefore,  a  capital  expenditure.  The  stockholder  could  not 
deduct  the  amount  paid  in  rendering  his  individual  return. 

It  follows,  of  course,  (as  will  be  explained  in  another  paragraph) 
that  when  such  a  payment  is  not  allowable  as  a  deduction  to  the 
stockholder,  it  is  not  income  to  the  corporation  receiving  it. 

75.— PREMIUM  ON  BOND. 

A  premium  paid  on  a  fidelity  bond  by  an  employee  (when  he  is 
required  to  furnish  bond,)  or  on  the  faithful  performance,  labor  and 
material  or  other  surety  bonds  given  by  contractors  or  others  in  con- 
nection with  business  transactions,  is  a  business  expense  allowable  as 
a  deduction.  Under  this  rule  would  come  the  premiums  on  the  bonds 
required  by  the  Government  from  distillers,  wine-makers,  liquor  deal- 
ers, brewers  and  cigar  and  tobacco  manufacturers,  covering  both  the 
manufacture  and  movement  of  their  products. 

76.— COMMISSIONS  AND  FEES. 

Commissions  and  fees,  required  to  be  paid  in  the  transaction  of 
business  are  items  of  business  expense  allowable  as  deductions ;  ex- 
amples of  such  items  being  commissions  paid  real  estate  agents  and 
salesmen  and  fees  paid  for  professional  services  rendered  in  connec- 
tion with  the  business  of  the  taxpayer. 

77.— INSURANCE  PREMIUMS. 

The  cost  of  insurance  on  property  which  is  not  occupied  by  the 
owner  as  a  dwelling  is  allowable  as  a  deduction.  The  rule  is  that  the 
cost  of  all  business  insurance  is  a  legitimate  business  expense  and  the 
amount  of  the  premium  paid  during  the  year  may  be  deducted.  This 
may  be  the  premium  on  fire  insurance,  burglary  or  general  liability 
insurance,  workmen's  compensation  insurance,  or  other  form  of  in- 
surance required  in  connection  with  the  taxpayer's  Business.  It 
covers  also  insurance  on  merchandise,  stock,  crops  and  business 
equipment  of  any  kind,  as  well  as  insurance  on  buildings. 

Premiums  paid  on  life  insurance  policies  by  the  insured  can  not 
be  deducted  in  his  return.  They  are  regarded  as  personal  expenses. 

78.— FARMER'S  DEDUCTIONS. 

A  farmer,  of  course,  is  entitled  to  every  deduction,  as  business 
expense,  allowable  in  any  other  kind  of  business,  provided  such  ex- 
pense be  necessary  in  the  operation  of  his  farm.  However,  there  are 


THE    INCOME   TAX  47 

certain  additional  items  of  expense  peculiar  to  the  business  of  farm- 
ing that  may  be  mentioned.  For  example,  the  farmer  may  deduct  the 
cost  of 

(a)  Stock  and  crops  bought  for  resale. 

(b)  Seed. 

(c)  Farming  tools  (but  not  machinery.) 

(d)  Feed  for  stock. 

(e)  Fertilizer. 

(f)  Tree  or  vine  spray. 

(g)  Crop  insurance. 

79.— ALIMONY. 

Any  amount  paid  as  alimony  is  not  allowable  as  a  deduction  in 
the  return  of  the  person  paying  it,  the  expenditure  being  regarded  as 
a  personal  expense.  However,  the  person  receiving  alimony  must  ac- 
count for  it  as  taxable  income. 

Likewise,  many  expenditures,  while  personal  expenses  and  there- 
fore not  allowable  deductions  to  those  paying  the  money,  must  be 
returned  as  taxable  income  by  recipients  of  them. 

80.— INTEREST  PAID. 

In  the  language  of  the  law  the  individual  (citizen  or  resident  of 
the  United  States)  can  deduct  from  gross  income  for  the  taxable  year 
All   interest  paid  within  the  year  on   his   indebtedness   ex- 
cept indebtedness  incurred  for  the  purchase  of  obligations  or 
securities  the  interest  upon  which  is  exempt  from  taxation 
as  income  under  this  title. 

The  exception  noted  in  the  paragraph  above  is  an  amendment 
carried  by  the  War  Revenue  Act  and  refers,  of  course,  to  indebted- 
ness incurred  for  the  pmpose  of  purchasing  securities  such  as  United 
States,  State,  County,  Municipal,  School,  Street  Improvement,  Irri- 
gation District,  Farm  Loan,  and  other  bonds  of  a  public  character, 
the  interest  upon  which  is  not  subject  to  income  tax. 

Any  amount  of  interest  deducted  must  have  been  paid  on  the 
personal  indebtedness  of  the  individual  during  the  year  for  which  the 
return  is  made. 

81.— TAXES  PAID. 

In  the  Income  Tax  law,  as  amended  by  the  War  Revenue  Act, 
the  provision  for  deduction  on  account  of  taxes  reads  as  follows  : 
Taxes  paid  within  the  year  imposed  by  the  authority  of 


48  THE   INCOME   TAX 

the  United  States  (except  income  and  excess  profits  taxes)  or 

of  its  Territories,  or  possessions  ;  or  any  foreign  country,  or  by 
the  authority  of  any  State,  county,  school  district,  or  munici- 
pality, or  other  taxing  subdivision  of  any  State,  not  including 
those  assessed  against  local  benefits. 

The  amendment  carried  by  the  War  Revenue  Act  is  the  exception 
of  Federal  income  and  excess  profits  taxes.  The  amount  of  these 
taxes  paid  during  the  year  for  which  return  is  filed  cannot  be  deducted 
from  gross  income  in  filing  a  return.  However,  in  assessing  income 
tax,  there  will  be  allowed  a  credit  against  the  net  income  shown  in  the 
return  of  the  excess  profits  tax  assessed  for  the  same  tax  year.  The 
limitation  written  into  the  law  does  not  refer  to  the  income  tax  im- 
posed by  any  State.  Such  a  tax  is  obviously  still  allowable  as  a  de- 
duction in  the  return  for  the  year  in  which  it  has  actually  been  paid. 

82.—TAXES  AGAINST  LOCAL  BENEFITS. 

The  other  limitation  in  the  law  with  respect  to  deduction  on  ac- 
count of  taxes  paid  is  that  covering  "taxes  assessed  against  local 
benefits." 

By  such  taxes  are  meant  payments  made  pursuant  to  assessment 
levied  by  a  special  district — an  assessment  confined  in  its  application 
to  property  within  a  certain  limited  area  and  resulting  in  a  local  bet- 
terment of  that  property.  A  case  in  point  is  the  cost  of  street  im- 
provement or  sidewalk  construction  within  a  specified  district  of  a 
city.  The  district  covered  by  the  assessment  may  be  small  in  relation 
to  the  size  of  the  city  (such  is  generally  the  case  with  respect  to  a 
street  or  sidewalk  assessment),  or  it  may  be  more  extensive  and  af- 
fect property  within  a  much  greater  area  as  in  the  case  of  so  well 
known  an  improvement  as  the  Twin  Peaks  Tunnel  in  San  Francisco. 
A  tax  of  this  kind  is  not  allowable  as  a  deduction. 

And  the  Treasury  Department  has  ruled  that  the  limitation  has 
reference  also  to  an  irrigation,  reclamation,  or  drainage  district 
assessment  where  local  improvement  is  again  the  purpose  of  the  ex- 
penditure. The  municipality  seems  to  be  the  smallest  taxing  unit 
acceptable  to  the  Government  as  capable  of  imposing  a  tax  sufficiently 
general  in  application  to  be  allowable  as  a  deduction. 

83.— STATE  INHERITANCE  TAX. 

A  collateral  inheritance  tax,  levied  under  the  laws  of  a  State  and 
made  a  charge  against  the  corpus  of  the  estate,  has  been  held  by  the 
Treasury  Department  to  constitute  such  an  item  of  expenditure  as 
cannot  be  allowed  as  a  deduction  in  computing  the  income  tax  liability 
of  either  the  beneficiary  of  the  inheritance  or  the  estate. 


THE    INCOME  TAX  49 

84.— TAXES  PAID  BY  A  BANK. 

A  great  deal  of  confusion  has  arisen  over  the  payment  to  the 
State  directly  by  a  bank  of  taxes  assessed  against  the  stockholders 
of  the  bank  in  proportion  to  the  number  of  shares  of  stock  held  by 
each.  Such  a  tax,  the  Treasury  Department  holds,  is  in  reality  paid 
by  the  bank  in  behalf  of  its  stockholders.  It  becomes,  therefore,  a 
proper  deduction  for  each  stockholder  to  claim,  according  to  his  in- 
terest ;  but  cannot  be  claimed  as  a  deduction  by  the  bank.  As  herein- 
before explained,  however,  the  stockholder  must  at  the  same  time 
account  for  the  amount  of  the  tax  upon  his  shares  as  an  additional 
dividend  from  those  chares. 

85.^-CUSTOMS  DUTIES. 

Import  duties  are  also  deductible  taxes  in  the  return  of  an  indi- 
vidual required  to  pay  them.  In  the  case  of  a  person  engaged  in  the 
importation  of  merchandise  as  a  business  the  amount  of  customs 
charges  may  be  added  to  the  cost  of  the  merchandise,  if  preferable, 
or  may  be  treated  as  a  payment  of  tax.  In  any  case  it  is  allowable 
as  a  deduction. 

86.— TAXES  MUST  BE  PAID. 

To  be  allowable  as  a  deduction,  however,  the  tax  must  actually 
have  been  paid  within  the  year  for  which  the  return  of  income  is  ren- 
dered. Where  an  annual  local  assessment  becomes  due  in  two  in- 
stallments, in  different  calendar  years,  it  follows  that  the  amount 
claimed  as  a  deduction  by  an  individual  in  his  return  for  the  first  cal- 
endar year  is  frequently  the  sum  of  the  second  installment  of  the  local 
assessment  for  the  year  before  (paid  in  the  year  for  which  the  return 
is  rendered)  and  the  first  installment  of  the  local  assessment  for  the 
year  for  which  the  return  is  rendered. 

87.— FOREIGN  TAXES. 

There  is  no  limitation  with  respect  to  a  tax  paid  to  a  foreign 
government.  The  entire  amount  of  the  tax  paid  within  the  year  may 
be  deducted.  This  also  includes  any  foreign  income  tax  even  though 
the  United  States  income  tax  is  not  allowable  as  a  deduction. 

However,  a  foreign  tax  payment  is  deductible  only  in  the  return 
of  a  citizen  or  resident  of  the  United  States.  It  cannot  be  charged 
against  his  income  from  sources  within  the  United  States  by  a  non- 
resident alien. 


50  THE    INCOME  TAX 

88.— LICENSE  AND  STAMP  TAXES. 

Local  license  taxes,  State  excise  or  franchise  taxes  and  the  Fed- 
eral license,  stamp  and  occupational  taxes  are  all  proper  deductions. 
In  this  connection  may  be  mentioned  such  expenditures  as  those  made 
by  various  kinds  of  business  for  municipal  or  county  licenses,  those 
payments  to  the  State  for  licenses  and  franchises  and  those  payments 
to  the  Government  either  in  the  purchase  of  Internal  Revenue  stamps 
or  for  the  privilege  of  conducting  business.  The  exception  with  re- 
spect to  the  Federal  Income  and  Excess  Profits  taxes  should,  however, 
be  kept  in  mind. 

89.— LOSSES  DEDUCTIBLE. 

The  allowance  for  losses — and  the  Treasury  Department's  strict 
ruling  on  every  point  that  has  arisen — has  caused  more  confusion  and 
brought  more  controversy  between  government  officials  and  tax- 
payers than  any  other  feature  of  the  Income  Tax  law.  Properly  this 
allowance  for  losses  may  be  divided  into  three  distinct  provisions  as 
follows : 

(a)  Losses  arising  from  fires,  storms,  or  shipwreck,  or 
other  casualty,  and  from  theft,  when  such  losses  are  not  com- 
pensated for  by  insurance  or  otherwise. 

(b)  Losses  sustained  in  the  business  or  trade  of  the  in- 
dividual who  makes  the  return. 

(c)  Losses    sustained    in    transactions    that    have    been 
entered  into  for  profit  but  are  not  connected  directly  with  the 
business  or  trade  of  the  individual  who  makes  the  return. 
Before  attention  is  given  to  each  of  the  above  kinds  of  losses, 

certain  general  restrictions  imposed  by  the  Government  in  its  inter- 
pretation of  the  law  should  be  emphasized. 

90.— LOSS  MUST  BE  ABSOLUTE. 

A  loss  to  be  allowable  as  a  charge  against  gross  income  must 
have  been  actually  sustained  and  ascertained  during  the  year  for 
which  the  return  is  filed.  The  Government  insists  upon  an  exact 
definition  of  the  words  "actually  sustained  during  the  year,"  appear- 
ing in  the  law.  The  loss  must  be  absolute  and  must  result  from  a 
transaction  which  has  been  completed.  It  must  be  the  outcome  of 
dealing  in  property,  real  or  personal,  which  has  been  closed  and  does 
not  offer  further  opportunity  for  either  additional  loss  or  recovery 
from  loss.  Where  an  investment  has  been  continued  by  the  taxpayer 
and  his  loss  is  represented  only  by  a  decrease  in  the  value  of  the 


THE   INCOME  TAX  51 

property  he  holds  there  has  not  been  sustained  a  loss  which  can  be 
allowed  as  a  deduction,  according  to  the  Treasury  Department's 
ruling.  In  other  words,  the  uncertainty  of  fluctuation  in  value  cannot 
be  considered;  the  transaction  must  have  been  closed  and  the  loss 
must  have  been  thus  determined  during  the  year  for  which  the  return 
is  made. 

91.— LOSS  FROM  CASUALTY. 

To  revert  to  the  classification  of  losses  under  three  general  defi- 
nitions, consider,  first,  the  loss  from  fire,  storm,  shipwreck,  or  other 
casualty,  or  from  theft,  when  such  loss  is  not  compensated  for  by 
insurance,  or  otherwise. 

If  the  insurance  is  insufficient,  the  loss  in  excess  of  the  amount 
of  insurance  received  may  be  claimed  as  a  deduction.  Cost  should  be 
taken  as  the  basis  of  computation  in  such  a  case.  If  the  insurance 
received  is  full  compensation  for  the  property  destroyed,  or  lost,  no 
deduction  on  account  of  the  casualty  can  be  claimed,  and  no  account 
need  be  rendered  of  the  receipt  of  the  insurance  in  making  a  return 
of  income. 

92.— LOSS   IN  BUSINESS  OR  TRADE. 

But  with  respect  to  a  loss  sustained  in  business  or  trade  the 
Treasury  Department  has  applied  the  strictest  kind  of  interpretation 
to  the  language  of  the  law. 

First,  there  is  the  loss  incurred  in  the  taxpayer's  business  or  trade 
during  the  year.  Then,  there  is  the  loss  incurred  in  transactions 
entered  into  for  profit  by  the  taxpayer  but  not  connected  with  his 
business  or  trade.  The  experience  of  the  writer  in  administering  the 
Income  Tax  law  is  that  the  public  has  never  become  reconciled  to 
the  Treasury  Department's  interpretation  of  the  Act  in  this  respect. 
In  a  way,  the  decisions  of  the  department  are  conflicting,  as  will  be 
pointed  out;  at  least  they  are  sufficiently  indefinite  to  leave  doubt  in 
the  mind  of  the  taxpayer. 

A  loss  incurred  in  the  taxpayer's  business  or  trade  is  deductible 
in  full.  A  loss  incurred  in  transactions  entered  into  for  profit  by  the 
taxpayer,  but  not  connected  with  his  business  or  trade,  is  deductible 
only  to  an  amount  not  exceeding  profits  from  other  transactions  of  a 
similar  kind  during  the  year. 

93.— WHAT  IS  A  MAN'S  BUSINESS? 

And  so  it  has  become  necessary  for  the  Treasury  Department 
to  attempt  to  say  what  is  an  individual's  business  or  trade  and  when 
a  transaction  is  not  connected  with  that  business  or  trade. 


52  THE   INCOME   TAX 

Says  the  Department  in  Treasury  Decision  2090: 

The  term  "in  trade,"  as  used  in  the  law  is  held  to  mean 
the  trade  or  trades  in  which  the  person  making  the  return 
is  engaged;  that  is,  in  which  he  has  invested  money  otherwise 
than  for  the  purpose  of  being  employed  in  isolated  transac- 
tions, and  to  which  he  devotes  at  least  a  part  of  his  time  and 
attention.  A  person  may  engage  in  more  than  one  trade  and 
deduct  losses  in  all  of  them,  provided,  that  in  each  trade  the 
above  requirements  are  met.  As  to  losses  on  stocks,  grain, 
cotton,  etc.,  if  these  are  incurred  by  a  person  engaged  in  trade 
to  which  the  buying  or  selling  of  stocks,  etc.,  are  incident  as 
a  part  of  the  business,  as  by  a  member  of  a  stock,  grain,  or 
cotton  exchange,  such  losses  may  be  deducted.  A  person 
can  be  engaged  in  more  than  one  business,  but  it  must  be 
clearly  shown  in  such  cases  that  he  is  actually  a  dealer,  or 
trader,  or  manufacturer,  or  whatever  the  occupation  may  be, 
and  is  actually  engaged  in  one  or  more  lines  of  recognized 
businesses. 

The  Government  insists  that  the  above  requirements  be  met  be- 
fore the  full  amount  of  a  loss  may  be  allowed  as  a  deduction.  The 
result  is  controversy  without  end.  Before  the  Income  Tax  law  was 
amended  and  re-enacted  by  the  Act  of  September  8,  1916,  no  amount 
of  loss  sustained  in  a  transaction  not  connected  with  the  business  or 
trade  of  the  individual  was  deductible,  according  to  the  ruling  in 
Treasury  Decision  2090,  and  before  that  in  Treasury  Decision  2005. 
With  the  law  in  its  present  form,  and  the  ruling  still  the  same,  only  so 
much  of  such  loss  may  be  deducted  as  the  amount  of  the  loss  does  not 
exceed  a  profit  from  a  similar  transaction.  If  there  has  been  no  profit 
during  the  year,  no  loss,  however  great,  may  be  deducted. 

The  condition  of  confusion  is  one  that  requires  tha  c  each  taxpayer 
do  his  best  to  comply  with  the  Treasury  ruling.  Each  case,  each  loss, 
must  be  considered  on  its  own  merits. 

The  difficulty  comes,  however,  from  the  application  of  the  Treas- 
ury ruling.  The  Department  has  plainly  stated  that  an  individual 
may  be  engaged  in  more  than  one  trade  or  business  ;  and  yet  in  prac- 
tice it  has  repeatedly  denied  individuals  this  privilege  in  connection 
with  allowance  for  losses. 

A  case  in  point  is  refusal  to  allow  a  banker  and  investor  to  de- 
duct in  full  his  losses  in  stocks  and  the  promotion  of  manufacturing 
ventures,  when,  as  a  matter  of  fact,  he  gives  as  rrmch  time  to  his 
stock  investments  and  industrial  promotions  as  to  his  banking  activ- 
ities. He  happens,  however,  to  have  the  title  of  bank  president. 


THE   INCOME   TAX  53 

Another  case  is  the  disallowance  of  the  full  amount  of  losses 
claimed  by  an  investor  in  connection  with  real  estate  investments,  the 
Treasury  Department  holding  that  only  a  person  whose  business  is 
that  of  a  real  estate  dealer  may  deduct  in  full  his  losses  from  real 
estate  transactions. 

The  Treasury  Department  has  also  taken  the  position  in  its  in- 
structions to  field  investigating  officers  that  only  a  person  whose  busi- 
ness is  that  of  a  licensed  and  recognized  broker,  and  who  buys  and  sells 
securities  for  others  as  well  as  for  himself,  has  a  right  to  deduct  the 
full  amount  of  any  loss  sustained  in  handling  stocks  and  bonds. 

These  references  to  the  position  of  the  Treasury  Department  are 
made  merely  in  illustration.  Obviously,  under  the  original  Income 
Tax  Law,  the  Act  of  October  3,  1913,  the  Treasury  Dej  artment  sought 
merely  by  regulation  to  prevent  deduction  of  speculative  losses.  Then 
in  the  Act  of  September  8,  1916,  Congress,  in  part,  acceded  to  the 
stand  taken  by  the  Treasury,  and  wrote  in  the  fifth  paragraph  of  sub- 
division (a)  of  Section  5  (note  text  of  law).  This  amendment  pro- 
vides for  allowance  of  a  speculative  loss  only  in  a  year  when  the  tax- 
payer has  enjoyed  a  speculative  profit,  and,  even  then,  never  to  an 
amount  in  excess  of  the  profit. 

An  example :  A  lawyer  invests  in  two  issues  of  stock  and  sells 
both  during  the  year.  In  one  transaction  he  loses  $10,000  but  in  the 
other  makes  a  profit  of  $5,000.  He  can  claim  deduction  for  a  loss 
of  only  $5,000,  and  at  the  same  time  must  include  his  profit  of  $5,000, 
in  the  latter  transaction,  in  his  statement  of  gross  income. 

Another  example :  The  lawyer  loses  in  both  transactions,  selling 
one  lot  of  stock  for  $10,000  less  than  cost  and  the  other  for  $5,000 
less.  He  has  made  no  profit  in  a  similar  transaction  during  the  year, 
and  so  cannot  claim  as  a  deduction  any  part  of  his  total  loss  of  $15,000. 

94.— TAXPAYER'S  COURSE. 

It  is  suggested  that  the  individual  adopt  the  following  course: 

1. — Deduct  in  full  every  business  or  trade  loss  sustained 
during  the  year  if  transactions  of  the  general  character  of 
that  in  connection  with  which  the  losses  have  been  incurred 
have  engaged  a  part  of  his  time  and  attention  in  the  ordi- 
nary course  of  affairs  from  year  to  year  and  are  not  to  him 
merely  isolated  and  speculative  ventures. 

2. — In  connection  with  the  explanation  of  the  loss  deduc- 
tion which  he  is  required  to  make,  attach  a  rider  to  his 
return  calling  attention  to  the  fact  that  he  is  engaged  in 


54  THE   INCOME   TAX 

more  than  one  trade  or  business,  and  furnishing  evidence  of 
the  fact. 

3. — Fall  back  upon  the  provisions  of  the  fifth  paragraph 
of  subdivision  (a)  of  Section  5  of  the  law  only  in  the  case  of 
a  transaction  strictly  speculative  and  isolated,  with  respect 
to  its  character,  from  the  course  of  his  ordinary  business 
affairs. 

The  individual  will  be  within  his  rights  if  he  follows  the  sug- 
gestion just  made.  He  knows  whether  he  is  engaged  in  one  business, 
or  more  than  one  business,  and  it  is  his  right  to  make  his  claim  for 
deduction  on  account  of  losses  accordingly.  By  doing  so  he  risks  no 
penalty  but  may  save  hundreds  (or  possibly  thousands)  of  dollars  in 
taxes  that  he  does  not  legitimately  owe  and  should  not  be  assessed. 

95.— HOW  TO  ASCERTAIN  LOSS. 

In  the  event  a  loss  is  deductible  it  must  be  ascertained  according 
to  one  of  two  general  methods. 

1. — When  sustained  from  the  sale  or  other  disposition 
of  property,  real,  personal  or  mixed,  acquired  before  March  1, 
1913,  the  amount  of  loss  must  be  determined  upon  the  basis 
of  the  fair  market  price  or  value  of  the  property  as  of  March 
1,  1913. 

2. — When  sustained  from  the  sale  or  other  disposition  of 
property  acquired  on  or  subsequent  to  March  1,  1913,  the 
amount  of  loss  must  be  determined  upon  the  basis  of  the  cost 
of  the  property. 

In  this  connection  it  is  suggested  that  the  reader  note  the  ex- 
planation given  with  respect  to  method  of  ascertaining  gain  from  the 
sale  or  disposition  of  property,  real  or  personal. 

96.— VALUE  AS  OF  MARCH   1,  1913. 

The  fair  market  price  or  value  of  real  property  as  of  March  1, 
1913  can  be  ascertained  by  considering  any  bona  fide  offer  made  im- 
mediately prior  to  that  date,  or  the  selling  price  at  about  that  time  of 
similar  property,  or  in  some  other  way  suggested  in  the  paragraph 
on  "Gain  from  Real  Property."  Sometimes  the  individual  must  fall 
back  upon  such  bases  as  local  assessment  and  court  appraisement  for 
a  working  foundation.  The  method  must  be  varied  to  fit  each  indi- 
vidual case  ;  it  is  impossible  to  lay  down  a  general  rule. 

And  in  some  respects  so  it  is  in  regard  to  the  fair  market  price  or 
value  of  personal  property,  particularly  securities,  as  of  March  1, 


THE   INCOME   TAX  55 

1913.  There  is,  however,  to  be  considered  the  fact  that  in  the  case 
of  many  such  securities  as  stocks  and  bonds  there  is  available  record 
of  the  price  at  which  they  were  selling  on  the  market  on  March  1, 
1913 ;  hence  in  any  such  case  the  determination  of  a  basis  of  loss 
computation  is  comparatively  simple. 

97.— COST  ON  OR  AFTER  MARCH  1,  1913. 

The  cost  of  property  acquired  on  or  after  March  1,  1913  (as 
a  basis  of  ascertaining  loss  or  gain)  is  held  by  the  Treasury  Depart- 
ment to  be  the  actual  price  paid  for  it,  plus  any  expense  incident  to 
purchase  and  sale,  and  the  cost  of  improvement,  if  any.  Special 
assessments,  which  have  added  to  the  value  of  the  property  and  have 
not  been  allowed  as  deductions  on  account  of  taxes,  also  become  a 
part  of  the  cost  of  the  property,  in  the  case  of  real  estate.  Such 
assessments  are  those  for  street  and  sidewalk  improvement,  local 
sewerage,  and  the  construction  of  irrigation  and  reclamation  works. 

98.— BAD  DEBTS. 

Deduction  for  bad  debts  is  allowed  only  when  the  debt  due  the 
taxpayer  has  been  actually  ascertained  to  be  worthless  and  has  been 
charged  off  within  the  year  for  which  the  return  is  made. 

It  is  not  sufficient  that  the  taxpayer  merely  regard  a  debt  as 
worthless.  He  must  have  made  some  effort  to  collect  and  must  have 
then  charged  off  the  amount  due  him  as  an  absolute  loss  in  his  own 
system  of  accounting.  The  insistence  of  the  ruling  is  that  there  be  no 
guessing  as  to  the  worthlessness  of  the  debt.  The  fact  of  loss  must 
be  established  to  make  the  amount  due  an  allowable  charge  against 
gross  income. 

99.— DEPRECIATION   DUE  TO  EXHAUSTION, 
WEAR  AND  TEAR. 

The  Federal  Income  Tax  law  provides  for  the  deduction  of  a 
"reasonable  allowance"  for  the  exhaustion,  wear  and  tear  of  physical 
property  used  in  the  business  of  the  taxpayer.  Such  "reasonable 
allowance"  may  be  claimed  in  a  return  of  income,  provided  the  fact 
that  it  is  "reasonable,"  within  the  meaning  of  the  Treasury  Depart- 
ment regulations,  can  be  established. 

^  However,  for  the  reason  that  the  subject  is  one  of  such  great  im- 
portance and  for  the  further  reason  that  both  individuals  and  corpora- 
tions must  follow  the  same  rules,  it  has  been  deemed  advisable  to  dis- 


56  THE    INCOME   TAX 

cuss  the  question  fully  with  detailed  illustrations,  in  a  separate  chap- 
ter under  the  heading,  "Depreciation  of  Physical  Property."     The 

reader  is,  therefore,  referred  to  the  special  chapter  on  the  subject. 

100.— DEPLETION  OF  OIL,  GAS  AND  ORE  DEPOSITS. 

Also,  the  taxpayer  is  allowed  to  deduct  a  "reasonable  allowance'" 

for  reduction  in  flow  of  oil  and  gas  from  wells,  and  for  depletion  of 
ore  deposits  in  mines. 

But,  as  in  the  case  of  depreciation  of  physical  property,  this  sub- 
ject is  one  with  which  both  individuals  and  corporations  are  con- 
cerned and  can  be  done  justice  only  in  a  separate  chapter  where  it  can 
be  gone  into  in  full  detail.  And  so  the  reader  is  referred  to  such 
special  chapter  under  the  heading,  "Depletion  of  Natural  Deposits." 

101.— GIFTS  TO  CHARITIES,  ETC. 

An  individual  is  also  allowed  as  a  deduction  contributions  or  gifts 
made  during  the  year  covered  by  his  return  to  charitable  and  other 
organizations  of  certain  classes,  but  the  deduction  on  this  account  can 
not  be  excess  of  15  per  cent  of  what  his  net  income  would  be  if  this 
particular  deduction  were  not  allowed.  In  order  for  such  a  contribu- 
tion or  gift  to  be  allowable  as  a  deduction,  the  organization  to  which 
it  is  made  must  have  been  formed  and  be  operated  exclusively  for  re- 
ligious, charitable,  scientific,  or  educational  purposes,  or  it  may  be  a 
society  for  the  prevention  of  cruelty  to  children  or  animals,  provided 
no  part  of  its  net  income  inures  to  the  benefit  of  any  private  individual. 


THE   INCOME   TAX  57 


CHAPTER  VII 


THE  INCOME  TAX 


CREDITS   IN   COMPUTATION  OF 
INDIVIDUAL  TAX. 


(The  credits  referred  to  in  this  chapter  are  those  allowed  citizens 
or  residents  of  the  United  States.) 

102.— CREDITS  ALLOWED. 

Even  after  the  individual  has  stated  in  full  his  gross  income  (ex- 
cluding, of  course,  income  exempt  from  tax)  and  has  claimed  the  de- 
duction to  which  he  is  entitled,  there  are  certain  credits  he  is  allowed 
in  the  computation  to  determine  his  tax  liability. 

103.— CREDIT  FOR  EXCESS  PROFITS  TAX. 

The  law  provides  that  in  assessing  income  tax  the  net  income 
shown  by  a  return  shall  be  credited  with  the  amount  of  any  excess 
profits  tax  assessed  for  the  same  tax  year.  The  amount  of  the  excess 
profits  tax  is  not  allowed  as  a  part  of  the  general  deduction  for  taxes 
in  ascertaining  net  income  (net  income  being  gross  income  less  de- 
ductions), but  when  net  income  has  been  ascertained  it  can  be  credited 
with  the  amount  of  excess  profits  tax  assessed  for  the  same  tax  year. 
Thus  the  amount  of  net  income  shown  by  the  return  less  the  excess 
profits  tax,  if  any,  assessed  for  the  same  tax  year  is  the  basis  of  in- 
come tax  assessment.  There  are,  however,  certain  other  credits  to  be 
considered  in  the  computation  of  normal  tax  liability.  They  are  ex- 
plained in  the  paragraphs  immediately  following. 

104.— CREDIT  FOR  DIVIDENDS. 

The  law  provides  that  "for  the  purpose  of  the  normal  tax  only, 
the  income  embraced  in  a  personal  return  shall  be  credited  with  the 


58  THE   INCOME   TAX 

amount  received  as  dividends  upon  the  stock  or  from  the  net  earn- 
ings of  any  corporation,  joint-stock  company  or  association,  or 
insurance  company,  which  is  taxable  upon  its  net  income." 

The  amount  received  as  dividends  must  be  stated  as  a  part  of 
gross  income  but  after  net  income  has  been  ascertained  by  subtract- 
ing the  total  amount  of  deductions  from  gross  income  and  after 
proper  credit  has  been  taken  for  excess  profits  tax,  if  any,  the  amount 
of  dividends  may  be  deducted  in  the  computation  of  normal  tax  lia- 
bility. 

However,  as  noted  above,  (in  the  case  of  a  net  income  running 
into  figures  to  make  it  subject  to  the  additional  tax)  the  determina- 
tion of  additional  tax  liability  is  entirely  another  consideration,  and 
into  such  computation  the  amount  of  dividends  must  enter.  On  this 
latter  point  the  law  reads  as  follows : 

"For  the  purpose  of  the  additional  tax  there  shall  be  in- 
cluded as  income  the  income  derived  from  dividends  on  the 
capital  stock  or  from  the  net  earnings  of  any  corporation, 
joint-stock  company  or  association,  or  insurance  company." 

105.— SPECIFIC  EXEMPTION. 

Credit  is  also  allowed  for  what  is  known  as  the  "specific  ex- 
emption," with  respect  to  the  net  income  of  every  individual  (citizen 
or  resident). 

This  specific  exemption  under  the  old  law  (Act  of  Sept.  8,  1916) 
is  as  follows  : 

(a)  A  single  person  who  is  not  the  head  of  a  family  is  al- 
lowed $3000. 

(b)  A  single  person  who  is  the  head  of  a  family  is  allowed 
$4000  and  an  additional  $200  for  each  dependent  child. 

(c)  A  married  man  living  with  his  wife,  or  a  married  woman 
living  with  her  husband,  is  allowed  $4000  and  an  additional 
$200  for  each  dependent  child. 

106.— HEAD  OF  FAMILY. 

The  Treasury  Department  has  defined  "the  head  of  a  family"  as 
follows  : 

"A  person  who  actually  supports  and  maintains  one  or 
more  individuals  who  are  closely  connected  with  him  by 
blood  relationship,  relationship  by  marriage  or  by  adoption 
and  whose  right  to  exercise  family  control  and  provide  for 
these  dependent  individuals  is  based  upon  some  moral  or 
legal  obligation." 


THE   INCOME   TAX  59 

The  law  specifies  that  a  "dependent  child"  must  be  under  eighteen 
years  of  age  or  incapable  of  self-support  because  mentally  or  phys- 
ically defective. 

Thus  an  unmarried  person  may  be  the  head  of  a  family,  as  in  the 
case  of  a  son  with  aged  parents  or  younger  brothers  and  sisters  (de- 
pendent children)  dependent  upon  him  for  support. 

Or  a  widow  with  dependent  children  would  meet  the  requirement 
of  the  Department. 

However,  a  widow  or  a  widower,  with  no  dependents,  is  entitled 
to  only  the  exemption  of  $3000  allowed  a  single  person  who  cannot 
qualify  as  the  head  of  a  family.  And  the  married  or  single  status  of 
a  person  must  be  determined  as  of  the  last  day  of  the  year  for  which 
the  return  is  filed.  Should  a  man's  wife  die  prior  to  the  end  of  the 
year,  even  though  she  had  lived  the  greater  part  of  the  year,  his 
status,  in  the  computation  of  income  tax  for  the  entire  year,  would 
be  that  of  a  single  person  and  he  would  be  allowed  an  exemption  of 
only  $3000  unless  he  could  qualify  as  the  head  of  a  family  or  had  been 
married  again  prior  to  the  end  of  the  year. 

107.— HUSBAND  AND  WIFE. 

The  law  provides  that  only  one  deduction  of  $4000  (as  an  exemp- 
tion) can  be  made  from  the  aggregate  income  of  both  husband  and 
wife  when  living  together,  and  that  the  additional  exemption  of  $200 
for  each  dependent  child  shall  operate  only  in  the  case  of  one  parent 
in  the  same  family.  If  husband  and  wife  file  separate  returns,  either 
may  claim  the  full  amount  of  the  exemption  or  they  may  prorate  the 
amount  between  themselves. 

108.— CREDIT  FOR  DEDUCTION  AT  SOURCE. 

The  total  normal  tax  liability  having  been  ascertained  by  taking 
credit  according  to  the  preceding  paragraphs  of  this  chapter,  the  in- 
dividual has  the  right  to  credit  such  total  normal  tax  liability  with  the 
amount  of  normal  tax,  if  any,  which  has  been  deducted  at  the  source. 
When  this  credit  has  been  taken,  the  result  should  be  the  amount  of 
normal  tax  due  the  government. 

109.— ADDITIONAL  TAX  DIFFERENT. 

Of  the  credits  mentioned  in  this  chapter  only  one  is  allowable 
o gainst  net  income  for  the  purpose  of  ascertaining  additional  tax  lia- 
bility. That  is  the  credit  for  amount  of  excess  profits  tax  assessed  for 


60  THE    INCOME   TAX 

the  same  tax  year.     Only  by  such  amount  can  the  net  income  shown 
by  a  return  be  reduced  before  the  additional  tax  is  computed. 

The  amount  represented  by  dividends  can  be  deducted  from  net 
income  and  the  specific  exemption  claimed  only  in  the  computation 
for  the  normal  tax.  It  also  follows  that  the  amount  of  normal  tax 
withheld  at  the  source  is  not  to  be  considered  in  the  computation  for 
the  additional  tax. 


THE   INCOME   TAX  61 


CHAPTER  VIII 

THE  INCOME  TAX 

FILING  OF  INDIVIDUAL  RETURN 


110.— PERIOD   COVERED. 

The  individual  return  of  income  is  based  upon  the  calendar  year 
beginning  January  1  and  ending  December  31.  In  this  the  language  of 
the  law  is  specific.  The  individual  is  not  allowed  the  privilege  of 
filing  a  return  according  to  a  fiscal  year,  as  is  the  corporation.  The 
Government  recognizes  just  the  one  income-tax  period  with  respect 
to  the  individual  and  that  is  the  Calendar  year. 

111.— WHEN  TO  BE  FILED. 

The  individual  return  of  income  must  be  filed  on  or  before  the 
first  day  of  March  for  the  preceding  Calendar  year.  This  means  that 
a  return  for  the  year  1917  must  be  filed  on  or  before  March  1,  1918. 

There  are  two  distinct  penalties  provided  for  neglect  or  refusal 
to  file  a  return  within  the  time  prescribed  by  law. 

One  takes  the  form  of  an  addition  of  50  per  cent  of  the  amount 
of  tax  shown  to  be  due. 

The  other  is  what  is  known  as  the  specific  penalty  and  consists  of 
a  fine  of  not  less  than  $20  nor  more  than  $1000. 

With  respect  to  either  of  these  penalties,  however,  the  taxpayer 
should  read  the  appropriate  paragraphs  in  the  chapter  on  "Penalties, 
Offer  in  Compromise  and  Prosecution." 

112.— BY  WHOM  TO  BE  FILED. 

In  view  of  the  fact  that  the  two  income  tax  laws  (Act  of  Septem- 
ber 8,  1916  and  Act  of  October  3,  1917)  are  to  be  administered  to- 
gether, the  question  of  liability  to  file  a  return  for  the  year  1917  and 
subsequent  years  must  be  determined  by  the  provisions  of  the  act  by 
which  the  amount  of  net  income  necessarv  to  create  such  liabilitv  has 


62  THE    INCOME   TAX 

been  reduced.  That  act  is  the  Act  of  October  3,  1917.  Under  it  a  re- 
turn must  be  filed  by  every  individual,  who  is  a  citizen  or  resident  of 
the  United  States,  according  to  the  following  circumstances  : 

(a)  A  single  person  with  a  net  income  for  the  year  of  $1,000  or 
more. 

(b)  A  married  person,  living  with  wife  or  husband,  with  a  net  in- 
come for  the  year  of  $2,000  or  more. 

A  non-resident  alien,  not  being  subject  to  the  War  income  tax, 
imposed  by  the  Act  of  October  3,  1917,  still  has  his  liability  to  file  a 
return  fixed  by  the  provisions  of  the  Act  of  September  8,  1916,  alone, 
and  these  provisions  are  that  every  non-resident  alien  with  a  net  in- 
come from  sources  within  the  United  States  of  $3,000  or  more  is  re- 
quired to  file  a  return. 

A  point  in  this  connection  deserving  emphasis  is  that  liability  to 
file  a  return  is  not  the  same  as  liability  to  tax.  It  is  important  that  the 
distinction  be  understood.  Under  the  law  a  single  person  with  a  net 
income  of  exactly  $1,000,  or  a  married  person  with  a  net  income  of 
exactly  $2,000,  is  required  to  file  a  return ;  yet  neither  would  have  any 
tax  to  pay.  Penalty  could  be  imposed,  however,  for  failure  to  file. 
Many  returns  are  filed  on  which  no  tax  is  assessed. 

113.— HOW  FILED. 

The  filing  of  a  return  means  the  delivery  of  the  return  to  the 
Collector  of  Internal  Revenue.  And  tbis  must  be  accomplished  on 
or  before  the  first  day  of  March.  Filing  with  a  Deputy  Collector  is 
regarded  the  same  as  filing  with  the  Collector. 

If  a  return  is  mailed  it  should  in  every  instance  be  forwarded 
under  either  a  registry  or  special  delivery  stamp,  so  that  the  taxpayer 
may  obtain  a  receipt  showing  the  time  of  the  arrival  of  the  return  in 
the  hands  of  the  Collector. 

Mailing  a  return  on  or  before  the  first  day  of  March  is  not  re- 
garded as  compliance  with  the  law  unless  sufficient  time  is  allowed 
for  the  return  to  reach  the  Collector,  in  the  ordinary  course  of  the 
mail,  within  the  time  prescribed.  These  points  are  not  trivial ;  indeed, 
their  importance  cannot  be  too  strongly  emphasized,  for  many  a  pen- 
alty has  been  imposed  in  the  face  of  proof  that  the  return  was  mailed 
on  or  before  the  first  day  of  March  but  not  in  time  to  reach  the  Col- 
lector's office  before  the  expiration  of  the  time  limit. 

114.— RECEIPT  FOR  RETURN. 

The  taxpayer  is  entitled  to  a  receipt  from  the  Collector  for  the 
filing  of  a  return.  He  should  ask  for  this  receipt,  whether  he  file  in 


THE   INCOME   TAX  t         63 

person  or  by  mail.  The  receipt  is  not  ordinarily  issued,  but  the  Treas- 
ury Department  has  provided  a  form  and  instructed  Collectors  to 
issue  a  receipt  whenever  one  is  requested.  The  suggestion  is,  there- 
fore, made  that  the  taxpayer  ask  for  a  receipt  for  his  own  protection. 
Experience  has  shown  that  in  the  rush  of  work  during  the  filing  per- 
iod returns  are  misplaced  or  lost  after  they  have  been  regularly  filed. 

115.— WHERE  FILED. 

The  return  should  be  filed  with  the  Collector  of  the  district  in 
which  the  individual  resides.  The  law  provides  that  it  be  filed  in  the 
district  where  the  individual  has  his  legal  residence  or  principal  place 
of  business,  but  the  Treasury  Department  has  directed  that  residence 
determines  the  place  of  filing. 

116.— FORM  TO  BE  USED. 

The  return  must  be  made  on  a  form  to  be  obtained  from  the  Col- 
lector of  Internal  Revenue,  at  his  headquarters,  or  from  one  of  his 
deputies  at  a  branch  office.  This  form  can  be  obtained  by  writing  and 
asking  for  the  form  for  individual  return.  [Prior  to  recent  amend- 
ment of  the  law  this  form  was  No.  1040.  Presumably  the  same  desig- 
nation will  apply  when  the  revised  forms  are  issued.] 

The  return  must  show  all  income  received  during  the  preceding 
calendar  year  (except  income  which  is  exempt  from  tax),  all  deduc- 
tions (with  proper  explanations)  and  the  specific  exemption  which  the 
individual  claims.  All  information  called  for  by  the  return  must  be 
given  in  the  spaces  provided  for  it. 

The  name  and  address  must  be  plainly  written  on  the  first  page. 
And  in  every  instance  the  return  must  be  made  under  oath.  It  may 

be  sworn  to  before  any  officer  qualified  to  administer  an  oath,  or  be- 
fore the  Collector  or  one  of  his  deputies. 

117.— EXTENSION  OF  TIME. 

In  certain  cases  it  is  possible  to  obtain  an  extension  of  time  for 
filing.  In  cases  of  sickness  or  absence  the  Collector  has  authority  to 
grant  an  extension  not  to  exceed  thirty  days  from  March  1.  When 
this  extension  is  desired  application  must  be  made  in  writing  to  the 
Collector  and  reason  given.  It  is  useless  to  apply  to  the  Collector  for 
an  extension  for  any  other  reason  than  sickness  or  absence,  as  the 
law  limits  his  authority.  However,  a  person  residing  or  traveling 
abroad  and  unable  to  file  his  return  on  or  before  March  1,  can  obtain 
a  further  extension  of  time  from  the  Commissioner  of  Internal  Rev- 
enue, provided  his  case  is  meritorious.  If  this  further  extension  is 


04  THE    INCOME   TAX 

required  written  application  should  be  made  to  the  Collector  with  the 
request  that  he  transmit  the  application  to  the  Commissioner,  whose 
office  is  in  Washington,  D.  C. 

When  a  return  is  filed,  after  an  extension  of  time  has  been  ob- 
tained, notation  of  the  extension  should  be  made  on  the  top  margin 
and,  if  possible,  a  copy  of  the  letter  granting  the  extension  should  be 
attached;  otherwise  the  person  filing  the  return  will  be  regarded  as 
delinquent  and  will  be  liable  to  penalty. 

118.— KEEP  COPY  OF  RETURN. 

Each  individual  should  retain  for  his  files  a  copy  of  his  return. 
If  an  extra  copy  of  the  official  form  can  be  obtained,  the  retained 
copy  should  be  kept  on  it ;  otherwise  a  form  for  the  retained  copy 
should  be  improvised.  This  is  important  to  the  taxpayer  in  the  event 
he  should  later  be  investigated  by  a  field  officer. 

119.— AGENT  OR  GUARDIAN  MAY  FILE. 

When  by  reason  of  minority,  insanity,  absence,  sickness  or  other 
disability  one  is  unable  to  make  his  own  return,  his  guardian  or  duly 
authorized  agent  must  act  for  him  and  comply  in  full  with  the  law 
and  be  subject  to  the  same  penalties  as  his  principal.  The  Treasury 
Department  has  held,  however,  that  a  person  acting  merely  under  a 
power  of  attorney  for  the  management  of  property,  where  no  legal 
trust  has  been  created,  does  not  have  to  assume  the  responsibility  of 
making  an  income  tax  return  for  his  principal. 

120.— NOTICE  TO  DELINQUENTS. 

After  the  returns  filed  on  or  before  March  1  have  been  properly 
recorded  the  Collector  of  Internal  Revenue  is  required  to  notify  every 
delinquent  of  whom  he  has  knowledge  and  who  has  not  filed  that  a 
return  is  expected  within  ten  days.  With  this  notice  he  is  supposed 
to  reach  not  only  those  who  have  filed  returns  in  previous  years  but 
also  those  concerning  whose  affairs  he  has  been  able  to  obtain  suffi- 
cient information  to  lead  him  to  believe  that  they  are  liable  to  file  re- 
turns. 

Immediate  attention  must  be  paid  to  such  notice  whenever  it  is 
received.  If  a  person's  income  has  fallen  below  that  of  previous 
years,  a  letter  of  explanation  should  be  written.  If  the  recipient  of 
the  notice  has  not  received  the  income  which  the  Collector  suspects 
him  of  having  received,  he  should  write  in  full. 

121.— COLLECTOR  CAN  MAKE  RETURN. 

The  law  gives  the  Collector  authority  to  call  witnesses  and  ex- 
amine accounts  in  case  of  neglect  or  refusal  to  file  a  return.  He  can, 


THE    INCOME   TAX  65 

indeed,  make  the  return  himself  and  such  return  would  be  acceptable 
as  a  basis  of  assessment  of  tax.  [See  similar  paragraph  in  instruc- 
tions given  corporations.] 

122.— CORRECTION   OF   A  RETURN. 

Whenever  a  return  is  received  back  from  a  Collector  with  in- 
structions to  alter  it,  the  directions  of  the  Collector  should  be  studied 
with  care.  The  taxpayer  is  not  obliged  to  follow  arbitrary  instruc- 
tions or  comply  with  a  peremptory  demand  with  respect  to  any  de- 
duction he  has  claimed,  for  instance,  unless  such  instructions  or  de- 
mand are  accompanied  by  an  explanation  of  the  law  and  regulations. 
In  other  words,  before  he  is  obliged  to  alter  his  return  or  prepare  a 
new  one,  the  taxpayer  has  the  right  to  be  shown  the  mistake  in  his 
original  return.  He  has  the  right  to  present  his  side  of  the  case  and 
should  do  so.  And  when  he  prepares  the  corrected  or  amended  re- 
turn he  should  mark  it  "Amended"  and,  in  forwarding  it  to  the  Col- 
lector, attach  to  it  the  original  incorrect  return.  This  is  necessary  in 
order  that  he  be  given  credit  for  having  filed  a  return  within  the  time 
prescribed  by  law. 

123.— FRAUDULENT  RETURN. 

For  the  filing  of  a  false  or  fraudulent  return  with  intent  to  evade 
tax  the  law  provides  two  distinct  penalties.  One  is  an  increase  of 
100  per  cent  in  the  amount  of  tax  found  to  be  due,  and  the  other  is  a 
fine  not  exceeding  $2000  or  imprisonment  not  exceeding  one  year,  or 
both. 

124.— ON   BASIS  OTHER  THAN   RECEIPTS. 

While  the  law  primarily  requires  that  a  return  be  based  upon 
income  received  and  deductions  actually  paid  out  during  the  year  for 
which  the  return  is  made,  it  does  contain  an  important  exception  in 
this  respect  with  reference  to  an  individual  in  the  following  language  : 

"An  individual  keeping  accounts  upon  any  basis  other 
than  that  of  actual  receipts  and  disbursements,  unless  such 
other  basis  does  not  clearly  reflect  his  income,  may,  subject 
to  regulations  made  by  the  Commissioner  of  Internal  Rev- 
enue, with  the  approval  of  the  Secretary  of  the  Treasury, 
make  his  return  upon  the  basis  upon  which  his  accounts  are 
kept,  in  which  case  the  tax  shall  be  computed  upon  his  in- 
come as  so  returned."  [See  similar  paragraph  in  instructions 
given  corporations.] 


66  THE    INCOME   TAX 


CHAPTER  IX 


THE  INCOME  TAX 


NON-RESIDENT   ALIEN   INDIVIDUALS 


125.— EXTENT  OF  TAX  LIABILITY. 

A  non-resident  alien  individual  must  pay  income  tax  on  all  in- 
come from  sources  within  the  United  States,  except  specifically  ex- 
empted income.  A  resident  alien — that  is,  an  alien  residing  in  the 
United  States — must  pay  tax  on  income  from  all  sources,  both  within 
and  without  the  United  States,  except  specifically  exempted  income, 
the  same  as  an  American  citizen ;  but  a  non-resident  alien  is  liable 
only  to  the  extent  of  his  net  income  from  the  United  States. 

126.— NOT  LIABLE  TO  WAR  INCOME  TAX. 

A  non-resident  alien  is,  however,  liable  only  under  the  old  law 
(the  Act  of  September  8,  1916.)  His  net  income  from  sources  within 
the  United  States  is  not  subject  to  the  extra  rates  imposed  by  the  Act 
of  October  3,  1917. 

127^-WHAT  CONSTITUTES  RESIDENCE. 

It  becomes  necessary,  therefore,  to  obtain  an  exact  understand- 
ing of  what  the  law  means  by  the  adjectives,  "Resident"  and  "Non- 
resident." In  Treasury  Decision  2242  the  Department  has  held  that 
"residence"  is  "that  place  wrhere  a  man  has  his  true,  fixed  and  perma- 
nent home  and  principal  establishment,  and  to  which  whenever  he  is 
absent,  he  has  the  intention  of  returning;  and  indicates  permanency 
of  occupation  as  distinct  from  lodging  or  boarding,  or  temporary 
occupation.  For  the  purpose  of  the  income  tax,  it  is  held  thaf  where 
for  business  purposes  or  otherwise,  an  alien  is  permanently  located  in 
the  United  States  ;  has  there  his  principal  business  establishment  and 
is  there  permanently  occupied  or  employed,  even  though  his  domicile 


THE    INCOME   TAX  67 

may  be  without  the  United  States,  he  will  be  held  to  be  within  the 
definition  of  'every  person  residing  in  the  United  States,  though  not  a 
citizen  thereof.'  " 

In  application  of  the  above  ruling  the  Department  has  held  that 
"aliens  who  are  physically  present  in  the  United  States,  but  only  tem- 
porarily resident  or  employed  therein  (as  for  a  season  or  similarly 
definite  term,  and  with  the  expectation  or  intention  of  leaving  the 
United  States  upon  the  termination  of  employment  or  accomplish- 
ment of  the  purpose  which  necessitated  presence  in  the  United 
States),  are  within  the  class  of  'Persons  residing  elsewhere'  " — that 
is,  are  non-resident  aliens. 

An  alien  who  has  come  to  the  United  States  with  the  intention  of 
becoming  a  permanent  resident  is,  under  the  general  interpretation  of 
the  law,  a  resident  alien. 

An  American  woman  who  marries  a  foreigner  assumes  the 
nationality  of  her  husband  and  is,  for  the  purposes  of  the  income  tax, 
a  resident  or  a  non-resident  alien  according  to  his  status  with  respect 
to  residence. 

128.— NO  SPECIFIC  EXEMPTION  ALLOWED. 

A  non-resident  alien  is  not  allowed  the  specific  personal  exemp- 
tion enjoyed  by  citizens  and  residents  of  the  United  States.  By  this 
exemption  is  meant  the  allowance  of  $3,000  or  $4,000,  according  to 
single  or  married  status. 

And,  likewise,  the  specific  exemption  of  $3,000,  given  to 

(a)  estates  of  deceased  citizens  or  residents  of  the  United  States 
during  the  period  of  administration  or  settlement,  and  to 

(b)  trust  or  other  estates  of  citizens  or  residents  of  the  United 
States,  the.  income  of  which  is  not  distributed  annually  or  regularly, 

is  not  allowed  to  similar  estates  of  non-resident  aliens. 

129.— NET  INCOME  OF  NON-RESIDENT  ALIEN. 

The  net  income  of  a  non-resident  alien  is  ascertained  by  taking 
from  gross  income  from  sources  within  the  United  States  the  deduct- 
tions  allowed  by  law. 

130.— DEDUCTIONS  LIMITED. 

These  deductions  are  limited,  however,  to  expenditures  or  losses 
immediately  connected  with  or  related  to  the  sources  within  the 
Un:ted  States  from  which  the  non-resident  alien  reports  his  income. 


68  THE    INCOME   TAX 

The  reader  is  referred  to  definitions  of  deductions  in  instructions 
given  citizens  and  residents  for  detailed  information.  Certain  specific 
limitations  may,  however,  be  noted  here  as  follows  : 

1.  Expenses    only    of   business    or   trade    carried   on    in   United 
States. 

2.  Interest — that  proportion  of  all  interest  which  gross  income 
from  United  States  bears  to  gross  income  from  all  sources    (less    in- 
terest on  indebtedness  incurred  to  buy  bonds  the  interest  on  which  is 
exempt  from  income  tax.) 

3.  Taxes  paid  in  the  United  States,  except  those  assessed  against 
local  benefits  ;   (Taxes  imposed  by  a  foreign  government  are  not  de- 
ductible by  a  non-resident  alien)  ;  except  also  United  States  Income 
and  excess  profits  taxes. 

4.  Losses  in  trade  in  United  States. 

5.  Losses  (speculative)  not  exceeding  profits  from  similar  tran- 
sactions in  United  States. 

6.  Bad  debts  arising  from    business    conducted    in    the    United 
States. 

7.  Depreciation  of  business  property  and  depletion  of  natural  de- 
posits only  in  the  United  States. 

131.— CREDITS  FOR  NORMAL  TAX. 

As  in  the  case  of  a  citizen  or  resident  of  the  United  States,  a  non- 
resident alien  is  allowed  credits  against  net  income  of  the  amounts 
representing  dividends  from  taxable  corporations  and  income  taxed  at 
the  source,  in  the  computation  for  the  normal  tax.  These  credits  are 
not  allowed,  however,  in  assessing  the  additional  tax. 

132.— BOTH  NORMAL  AND  ADDITIONAL  TAX. 

A  non-resident  alien  is  subject  to  both  the  normal  and  the  addi- 
tional tax  under  the  rates  of  the  Act  of  September  8,  1916,  according 
to  the  amount  of  his  income. 

However,  were  his  entire  income  from  corporation  dividends,  and 
in  excess  of  $20,000  for  the  year,  he  would  (under  the  Income  Tax  law 
of  September  8,  1916,  as  amended)  be  subject  only  to  the  graduated 
additional  tax. 

133.— MUST  MAKE  RETURN. 

In  order  to  receive  the  benefit  of  deductions  and  credits,  the  law 
requires  that  a  non-resident  alien  shall  make  an  accurate  return  of  all 
income,  except  exempt  income,  from  sources  within  the  United  States, 


THE    INCOME  TAX  69 

including  dividends.  If  he  fails  to  file  such  a  return,  the  Collector  of 
Internal  Revenue  must  proceed  to  collect  the  tax  due  on  his  income 
and  may  take  and  sell  any  of  his  property  to  satisfy  the  Government's 
claim. 

134.— WHERE  TO  FILE  RETURN. 

A  non-resident  alien  is  directed  to  file  his  return  of  income  in  the 
district  in  which  he  carries  on  his  principal  business  within  the  United 
vStates.  However,  if  he  has  no  such  principal  business,  and  in  all  cases 
of  doubt,  he  may  and  should  file  with  the  Collector  at  Baltimore,  Md., 
in  whose  district  Washington,  D.  C.  is  situated. 

135.— AGENT  CAN  MAKE  RETURN. 

The  return  of  a  non-resident  alien  can  be  made  by  a  resident 
agent  in  the  United  States.  In  fact,  the  Department  in  formal  Treas- 
ury Decisions  and  extensive  correspondence  has  insisted  that  in  all 
cases  where  resident  agents  are  responsible  for  the  American  in- 
terests of  their  principals  to  the  extent  of  being  in  charge  of  any  prop- 
erty owned,  or  business  carried  on,  such  resident  agents  must  make 
the  ieturns.  The  resident  agent  can  act  in  full  for  his  non-resident 
alien  principal,  can  swear  to  the  return  and  pay  the  tax  assessed. 
Moreover,  such  resident  agent  may  be  either  an  individual  or  a  cor- 
poration. If  a  corporation  acts  as  resident  agent,  such  corporation 
can  sign,  by  one  of  its  responsible  officers,  the  individual  return  made 
in  behalf  of  its  non-resident  alien  principal. 

The  return  herein  referred  to  (which  is  to  be  made  by  agent  for 
principal)  is  the  return  of  annual  net  income  required  of  the  non-resi- 
dent alien  individual,  and  not  the  withholding  agent's  return  required 
in  the  case  of  deduction  of  tax  at  the  source. 

136.— TRUSTEE  OR  EXECUTOR  TO  MAKE  RETURN. 

A  trustee,  executor,  administrator,  or  any  person  acting  in  a  fidu- 
ciary capacity  can  make  the.  individual  return  for  a  non-resident  alien 
beneficiary.  This  has  reference  to  a  return  similar  to  that  which 
would  be  made  by  an  agent  and  not  to  the  return  required  to  be  filed 
for  the  estate  of  a  deceased  person  during  the  period  of  administra- 
tion, or  to  the  return  required  of  any  other  estate  the  income  of  which 
is  not  annually  or  regularly  distributed,  or  to  the  withholding  agent's 
return  required  of  a  fiduciary  when  such  fiduciary  comes  under  the 
provisions  of  the  law  relative  to  deduction  of  the  normal  tax  at  the 
source. 


70  THE    INCOME   TAX 

137.— DEDUCTION  OF  TAX  AT  SOURCE. 

All  the  income  of  a  non-resident  alien  individual  from  the  United 
States  is  subject  to  deduction  of  the  normal  tax  at  the  source  except 
income  from  dividends  on  the  stock  of  a  corporation  subject  to  income 
tax.  Such  is  the  requirement  of  the  law  of  September  8,  1916,  as 
amended  by  the  War  Revenue  Act  of  October  3,  1917.  All  persons, 
corporations  or  partnerships  having  control  of  the  payment  of  any  in- 
come except  corporation  dividends  to  a  non-resident  alien  must  de- 
duct the  normal  tax,  as  prescribed  by  law,  and  make  return  and  pay- 
ment of  such  tax  to  the  Collector  of  Internal  Revenue.  [This  is  more 
fully  explained  in  the  special  chapter  on  ["Deduction  of  Tax  and  In- 
formation at  Source."] 

138.— FOREIGN  DIVIDENDS. 

A  non-resident  alien  is  not  required  to  include  in  his  return  of  in- 
come any  amount  received  as  dividends  on  the  stock  of  foreign  cor- 
porations, whether  such  dividends  are  payable  either  in  the  United 
States  or  abroad.  Particular  attention  is  called  to  this,  lest  the  re- 
quirement that  all  dividends  be  included  in  a  return  be  misunderstood 
as  far  as  its  application  to  non-resident  alien  individuals  is  concerned. 


THE   INCOME  TAX  71 


CHAPTER  X 


THE  INCOME  TAX 


PARTNERSHIPS 


139.— NOT  SUBJECT  TO  INCOME  TAX. 

A  partnership,  as  such,  is  not  subject  to  income  tax — except  a 
limited  partnership  which  has  been  held  by  the  Treasury  Department 
to  be  an  "association,"  within  the  meaning  of  the  law,  liable  to  make 
return  and  pay  tax.  An  ordinary  partnership  has  no  income-tax  lia- 
bility. The  individual  members  of  a  partnership  must,  however,  in- 
clude in  the  gross  income  stated  in  their  individual  returns  their  re- 
spective shares  of  the  net  earnings  of  the  partnership,  whether  such 
earnings  have  been  distributed  or  not. 

140.— INCOME  FROM  A  PARTNERSHIP. 

The  requirement  that  each  individual  member  of  a  partnership 
account  for  his  share  of  its  net  earnings  as  a  part  of  his  gross  income, 
whether  he  has  actually  received  such  share  by  way  of  distribution  or 
not,  has  necessitated  careful  definition  of  income  from  a  partnership. 

The  Department  holds  that  income  from  a  partnership  accrues  to 
the  individual  partner  at  the  time  his  distributive  interest  has  been  as- 
certained and  is  reducible  to  possession.  In  his  own  return  for  the 
calendar  year  the  individual  partner  must  include  income  accruing 
from  the  business  of  the  partnership  for  its  business  year  as  such  in- 
come is  shown  by  the  books  of  the  partnership,  whether  or  not  dis- 
tribution has  been  made  to  the  partners.  The  net  earnings  of  the 
partnership  thus  to  be  accounted  for  by  the  individual  members  are 
the  net  earnings  for  the  business  year  of  the  partnership  ending  in  the 
calendar  year  for  which  the  individuals  make  their  return. 

For  example:  The  partnership  of  "A  &  B"  closed  its  books  on 
September  30,  1917.  In  their  personal  returns  for  the  calendar  year 
ending  December  31,  1917,  A  and  B,  as  individuals,  must  include  their 


72  THE    INCOME   TAX 

respective  shares  of  the  net  earnings  of  the  partnership,  as  shown  by 
the  books  on  September  30,  whether  or  not  such  net  earnings  have 
actually  been  distributed. 

If  the  partnership's  business  year  should  close  the  last  day  of  De- 
cember, then  the  partners  would  include  in  their  returns  for  the  year 
ending  the  last  day  of  December  their  respective  shares  of  the  net 
earnings  as  shown  by  the  partnership's  books  on  that  date. 

It  follows,  of  course,  that  if  the  net  earnings  of  a  partnership  are 
not  actually  distributed  during  the  year  for  which  the  individual  part- 
ners account  for  them  in  their  personal  returns,  such  net  earnings, 
when  actually  paid  to  the  partners,  need  not  again  be  included  as  in- 
come received. 

141.— CREDITS   AGAINST   PARTNERSHIP    EARNINGS. 

As  the  individual  partner  is  required  to  include  in  his  statement 
of  gross  income  his  share  of  a  partnership's  net  earnings,  he  would, 
in  many  cases,  be  subjected  to  both  normal  and  additional  tax  on  his 
share  of  that  part  of  the  partnership's  income  represented  by  interest 
on  those  certain  bonds  (enumerated  hereinbefore)  the  interest  on 
which  is  exempt  from  tax;  and  he  would  be  subjected  to  normal  tax 
on  his  share  of  that  part  of  the  partnership's  income  represented  by 
dividends  from  corporations,  but  for  credits  specifically  provided  for 
in  the  law  as  follows : 

That  from  the  net  distributive  interests  on  which  the  individual 
members  shall  be  liable  for  tax,  normal  and  additional,  there  shall  be 
excluded  their  proportionate  shares  received  from  interest  on  the  obli- 
gations of  a  State  or  any  political  or  taxing  subdivision  thereof,  and 
upon  the  obligations  of  the  United  States  (if  and  to  the  extent  that  it 
is  provided  in  the  Act  authorizing  the  issue  of  such  obligations  of  the 
United  States  that  they  are  exempt  from  taxation)  and  its  possessions, 

And  that  for  the  purpose  of  computing  the  normal  tax  there  shall 
be  allowed  a  credit  *****  fOr  their  proportionate  share  of 
the  profits  derived  from  dividends. 

142.— RETURN  MAY  BE  REQUIRED. 

While  a  partnership  is  not  liable  to  income  tax  and  does  not,  in 
the  ordinary  course  of  its  business,  have  to  file  a  return,  the  statute 
gives  both  the  Commissioner  of  Internal  Revenue  and  a  district  Col- 
lector of  Internal  Revenue  authority  to  call  for  a  return.  At  any  time 
either  the  Commissioner  or  a  Collector  may  request  a  partnership  to 
file  a  return,  and  such  request  must  be  complied  with.  Moreover, 
such  return,  when  filed,  must  give  a  complete  statement  of  the  gross 
income  of  the  partnership,  and  of  the  deductions  and  credits  to  which 
it  is  entitled,  and  the  name  and  address  of  each  individual  partner  in 
terested  in  the  net  earnings  of  the  partnership. 


THE    INCOME   TAX  73 

Since  the  partnership,  as  such,  is  not  subject  to  income  tax,  this 
return,  when  called  for,  is  for  the  information  of  the  officials  of  the 
Government  and  not  for  assessment  of  tax  against  the  partnership. 
As  a  matter  of  fact,  the  purpose  in  calling  for  it  would  be  to  obtain 
data  desired  in  checking  the  personal  returns  of  the  individual  part- 
ners. 

The  return  should  not  be  filed  unless  called  for  by  either  the  Com- 
missioner or  a  Collector. 

143.— CAN  FIX  A  FISCAL  YEAR. 

A  partnership  can  designate  a  fiscal  year  of  its  own,  and  make  re- 
turn upon  such  basis,  if  called  upon  to  make  return.  It  has  the  same 
rights  in  this  respect  as  a  corporation. 

144.— WHEN  TAX  RATE  CHANGES. 

If  the  fiscal  year  of  a  partnership  should  at  any  time  comprehend 
parts  of  two  calendar  years  for  which  there  are  different  rates  of  tax. 
then  each  partner's  share  of  its  net  earnings  must  be  apportioned  for 
taxation  under  the  two  rates,  according  to  that  portion  of  the  partner- 
ship's fiscal  year  falling  within  each  of  the  two  calendar  years. 

145.— PARTNERSHIP  MUST  WITHHOLD  TAX 
AND  GIVE  INFORMATION  AT  SOURCE. 

Under  the  income  tax  law  of  1916,  as  amended  by  the  War  Rev- 
enue Act  of  October  3,  1917,  a  partnership  is  under  the  same  require- 
ments as  a  withholding  agent  with  respect  to  deduction  of  the  normal 
tax  at  the  source  as  are  corporations  and  individuals.  These  require- 
ments have  been  greatly  reduced  from  those  that  were  in  the  law 
prior  to  amendment  on  October  3,  1917. 

If  a  partnership  engages  in  the  business  of  making  collection  of 
foreign  payments  of  interest  or  dividends,  it  must  obtain  a  license  and 
submit  to  the  same  regulations  as  are  imposed  upon  corporations  and 
individuals. 

With  respect  to  information  at  the  source,  regarding  payments  to 
others,  the  partnership  stands  exactly  as  does  the  corporation  or  in- 
dividual. It  is  subject  to  the  same  general  requirements  and  liable  to 
the  same  general  penalties  for  refusal  or  neglect  to  obey  the  law. 

[See  chapter  on  "Deduction  of  Tax  and  Information  at  Source."] 

146.— CANNOT  DEDUCT  INSURANCE  PREMIUMS. 

In  computing  its  net  earnings,  in  order  that  the  individual  part- 
ners may  account  for  their  respective  shares  in  their  personal  returns, 
a  partnership  is  not  allowed  to  deduct  from  gross  income  premiums 


74  THE    INCOME   TAX 

paid  on  policies  insuring  the  lives  of  individuals,  (members  or  em- 
ployees) in  favor  of  the  business.  This  prohibition  was  written 
into  the  law  by  the  Act  of  October  3,  1917. 

Prior  to  such  amendment  the  ruling  was  that  while  the  annual 
premium  could  not  be  deducted,  as  paid  from  year  to  year,  the  aggre- 
gate of  premiums  paid  could  be  deducted  from  the  proceeds  of  the 
policy  in  ascertaining  the  amount  of  such  proceeds  to  be  included  as 
income. 


THE   INCOME   TAX  75 


CHAPTER  XI 


THE  INCOME  TAX 


DEDUCTION  OF  TAX  AND  INFORMATION 
AT  SOURCE. 


147.— LAW  RADICALLY  CHANGED. 

The  requirements  of  the  Income  Tax  law  with  respect  to  the  de- 
duction and  withholding  of  the  normal  income  tax  at  the  source  were 
radically  changed  by  amendments  carried  by  the  Act  of  October  3, 
1917.  Certain  of  the  deduction-at-the-source  features  have  been  re- 
tained and  for  others  have  been  substituted  requirements  that  infor- 
mation be  furnished  from  the  source  without  deduction  of  the  tax. 

148.— INCOME   OF   CITIZENS   OR 

RESIDENTS  OF  UNITED  STATES. 

All  of  the  requirements  relative  to  the  deduction  of  the  normal 
tax  from  the  income  of  individuals  who  are  citizens  or  residents  of 
the  United  States  have  been  repealed  with  the  exception  of  that  re- 
lating to  interest  on  bonds  containing  the  so-called  "tax-free"  coven- 
ant. Only  in  this  one  respect  is  a  corporation  or  its  paying  agent  .re- 
quired to  deduct  the  normal  tax,  and  then  only  at  the  rate  of  2  per 
cent.  The  individual  can,  however,  claim  exemption  for  deduction  at 
the  source,  in  which  case  no  tax  is  to  be  deducted.  In  collecting  his 
interest  the  bondholder  must  fill  out  an  ownership  certificate.  In  this 
certificate  he  can  either  claim  exemption  from  deduction  of  tax  at  the 
source,  or  not  claim  exemption.  If  he  does  not  claim  exemption,  the 
corporation  must  pay  the  normal  tax  upon  the  interest. 

In  either  case  original  tax  liability  remains  with  the  bondholder — 
the  recipient  of  the  interest.  This  liability  is  not  transferred  from 
bondholder  to  corporation  by  the  "tax-free"  covenant  in  the  bond. 


76  THE    INCOME   TAX 

If  the  bondholder  claims  exemption  in  filing  his  certificate  of 
ownership  at  the  time  he  collects  his  interest,  when  the  time  comes 
to  file  his  return  of  annual  income  with  the  Government  he  must 
enter  the  amount  of  interest  received  as  income  which  has  not  been 
subjected  to  tax  at  the  source. 

If  the  bondholder  does  not  claim  exemption  in  filing  his  certificate 
of  ownership  at  the  time  he  collects  his  interest,  when  the  time  comes 
to  file  his  return  of  annual  income  with  the  Government  he  must 
enter  the  amount  of  interest  received  as  income  which  has  been  sub- 
jected to  tax  at  the  source. 

It  is  of  the  utmost  importance  that  the  two  preceding  paragraphs 
be  understood  by  every  individual  holder  of  "tax-free"  industrial 
bonds.  Endless  confusion  has  resulted  from  a  clash  between  the 
withholding  provisions  of  the  Federal  law  and  the  "tax-free"  coven- 
ant in  such  bonds. 

To  illustrate : 

John  Smith  owns  $20,000  (par  value)  of  the  Western  Railway 
Company's  bonds  paying  5  per  cent  interest.  The  interest  is  pay-- 
able quarterly.  There  is  a  clause  in  the  bonds  by  which  the  railway 
company  agrees  to  pay  the  interest  without  deduction  for  taxes. 
What  happens  if  Smith,  desiring  to  pass  liability  for  the  tax  to  the 
railway  company,  decides  that  the  way  to  do  so  is  to  claim  exemption 
when  he  fills  out  the  ownership  certificate  required  when  he  collects 
his  interest? 

Having  claimed  exemption  in  collecting  a  year's  interest,  he  de- 
cides that  he  is  no  longer  liable  to  tax  on  the  interest  and  when  he 
makes  up  his  return  of  income  he  enters  the  amount  of  interest  as 
having  been  taxed  at  the  source.  This  is  not  what  should  be  done  but 
it  is  what  generally  has  been  done  by  the  individual  during  the  past 
(our  years. 

The  mistake  made  by  Smith  may  not  be  noticed  in  the  local  In- 
ternal Revenue  office  during  the  rush  of  the  filing  period,  but  eventual- 
ly it  will  be  discovered  in  the  Department  at  Washington  where  all 
ownership  certificates  are  filed  and  assembled,  and  Smith  will  be 
assessed  and  required  to  pay  the  tax  on  the  interest.  When  he  pro- 
tests that  the  bonds  are  "tax-free,"  he  will  be  told  that  the  Govern- 
ment is  not  concerned  with  the  "tax-free"  covenant,  that  the  liability 
is  his  and  that  in  claiming  exemption  at  the  time  he  filled  out  owner- 
ship certificates  he  specifically  released  the  railway  company  from  lia- 
bility to  pay  the  tax  to  the  Government  under  the  provisions  of  the 
Income  Tax  law. 


THE   INCOME   TAX  77 

On  the  other  hand,  if  at  the  time  he  collects  his  interest  and  fills 
out  the  requisite  ownership  certificates,  Smith  does  not  claim  exemp- 
tion, the  railway  company  is  under  obligation  to  pay  the  tax  to  the 
Government.  Smith,  then,  can  enter  the  amount  as  having  been  taxed 
at  the  source  when  he  files  his  return  of  income.  He  can  make  this 
kind  of  entry  and  benefit  by  the  credit  represented  by  it  even  though 
he  has  received  his  interest  in  full,  which  generally  has  happened  in 
the  case  of  interest  payments  on  "tax-free"  bonds,  whether  the  bond- 
holder has  or  has  not  claimed  exempt  ion. 

The  form  of  ownership  certificate  used  by  the  bondholder  i.-, 
what  determines  the  liability  of  the  bond-issuing  corporation  as  far 
as  the  Government  is  concerned.  The  Government  requires  that  the 
corporation  make  return  and  pay  the  normal  tax  in  the  case  of  every 
interest  payment  for  which  a  certificate  claiming  exemption  cannot 
be  furnished.  But  with  respect  to  interest  payments  for  which  it  has 
received  ownership  certificates  claiming  exemption,  the  corporation 
is  required  merely  to  deposit  the  certificates  with  the  Collector  for 
transmission  to  Washington  and  is  not  required  to  pay  tax  at  the 
source. 

149.— INCOME  OF  NON-RESIDENT 
ALIEN  INDIVIDUALS. 

All  of  the  income  of  non-resident  alien  individuals,  from  sources 
within  the  United  States,  is  still  subject  to  the  deduction  of  the  nor- 
mal tax  at  the  source  with  the  exception  of  dividends  from  domestic 
corporations. 

All  persons,  corporations,  partnerships  and  associations,  having 
control,  receipt,  custody,  disposal  or  payment  of  income  of  any  kind, 
except  dividends,  from  the  United  States  to  foreigners  residing  under 
other  flags  must  deduct  the  normal  tax  of  2  per  cent  and  make  return 
and  payment  to  the  Collector  of  Internal  Revenue.  Moreover,  a  non- 
resident alien,  not  being  entitled  to  the  specific  exemption  allowed 
other  individuals,  can  not  claim  exemption  from  deduction,  at  the 
source. 

)  50.— INCOME  OF  FOREIGN  CORPORATION 
FROM  UNITED  STATES. 

The  income  of  a  foreign  corporation  from  sources  wthin  the 
United  States  is  subject  to  deduction  of  tax  at  the  sourci  in  two  re- 
spects, provided  such  corporation  is  not  engaged  in  business  or  trade 
in  the  United  States  and  does  not  have  an  office  or  place  of  business 
in  this  country. 


78  THE    INCOME   TAX 

1. — The  income  derived  by  such  a  corporation  from  dividends  on 
the  stock  of  a  domestic  corporation  is  subject  to  deduction  of  tax  at 
the  source  to  the  amount  of  2  per  cent. 

2. — The  income  derived  by  such  a  corporation  from  interest  on 
American  corporation  bonds  is  subject  to  deduction  of  tax  at  the 
source  to  the  amount  of  6  per  cent. 

151.— FOREIGN  PARTNERSHIP  NOT  SUBJECT 
TO  DEDUCTION  AT  SOURCE. 

Payments  of  domestic  corporation  dividends  or  bond  interest,  or 
of  income  in  any  other  form,  to  a  foreign  partnership  is  not  subject  to 
deduction  of  tax  at  the  source.  True,,  Subdivision  (e)  of  Section  13 
6i  the  Act  of  September  8,  1916,  as  amended  by  the  Act  of  October  3, 
1917,  states  that  the  withholding-at-the-source  requirement  with  re- 
spect to  bond  interest  "shall  be  made  applicable  to  the  tax  imposed  by 
subdivision  (a)  of  Section  10  (of  the  Act  of  September  8,  1916)  upon 
incomes  derived  from  interest  upon  bonds  and  mortgages  or  deeds  of 
trust  or  similar  obligations  of  domestic  or  other  resident  corporations, 
joint-stock  companies,  or  associations,  and  insurance  companies,  by 
non-resident  alien  firms,  copartnerships,  companies,  corporations, 
joint-stock  companies  or  associations,  and  insurance  companies,  not 
engaged  in  business  or  trade  within  the  United  States  and  not  having 
any  office  or  place  of  business  therein." 

But  Subdivision  (a)  of  Section  10,  above  referred  to,  does  not  im- 
pose an  income  tax  upon  the  income  of  foreign  partnerships ;  there- 
fore, no  tax  is  to  be.  deducted  when  payments  are  made  to  them.  The 
Department  has  so  held. 

152.— DOMESTIC  CORPORATIONS  AND 
PARTNERSHIPS  NOT  SUBJECT  TO 
DEDUCTION  AT  SOURCE. 

The  income  of  a  domestic  corporation  or  partnership  is  not  sub- 
ject to  deduction  of  the  tax  at  the  source  upon  income  paid  in  any 
form.  It  has  in  the  past  been  held  necessary,  however,  for  such  or- 
ganizations to  file  ownership  certificates  when  presenting  bond 
coupons  or  interest  orders  for  collection.  Under  the  law  as  amended 
they  will  still  have  to  do  so  with  respect  to  coupons  and  interest 
orders  for  interest  payments  upon  "tax-free"  bonds. 

153.— WHO  IS  "WITHHOLDING  AGENT"? 

The  regulations  of  the  Treasury  Department  and  the  official  in- 
come tax  forms  contain  many  references  to  "withholding  agents." 


THE   INCOME   TAX  79 

The  withholding  agent  is  the  source  of  the  income. 

In  the  case  of  bond  interest  payments  the  withholding  agent  is 
the  interest-paying  corporation  or  its  regularly  designated  paying 
agent. 

In  the  case  of  payment  of  salaries,  rent,  etc.,  the  withholding 
agent  would  be  the  employer,  lessee,  etc.,  making  such  payments  to  a 
non-resident  alien. 

In  the  case  of  dividend  payments  by  a  domestic  corporation  to  a 
foreign  corporation  having  no  office  or  place  of  business  in  the  United 
States,  the  withholding  agent  would  be  the  domestic  corporation. 

A  withholding  agent  can  be  an  individual,  a  corporation,  a  part- 
nership or  any  kind  of  association  or  organization. 

154.— REFUND  OF  TAX  WITHHELD 
IN  1917  AUTHORIZED. 

All  amounts  of  tax  withheld  at  the  source  during  1917  from  the 
income  of  individuals  who  are  citizens  or  residents  of  the  United 
States,  with  the  exception  of  that  withheld  from  interest  payments  on 
"tax-free"  bonds,  must  be  returned  to  the  owners.  This  covers 
amounts  withheld  from  salaries,  rents,  ordinary  note  interest,  and  any 
other  form  of  income  of  an  individual  citizen  or  resident  of  the  coun- 
try which  was  formerly  subject  to  deduction  of  tax  at  the  source. 
Employers,  lessees  and  others  who  withheld  the  tax  from  payments 
made  during  the  year  1917,  are  authorized  and  directed  by  law  to  pay 
back  the  amounts.  The  Government  will  expect  the  individuals  re- 
ceiving the  income  to  include  all  such  income  in  their  returns  as  not 
having  been  taxed  at  the  source. 

155.— DUTIES  OF  THOSE  WHO  DEDUCT 
TAX  UNDER  AMENDED  LAW. 

Those  persons,  corporations  or  partnerships 

(a)  making  payments  of  any  kind,  except  domestic  corpora- 
tion dividends,  to  a  non-resident  alien  individual ; 

(b)  or  making  payments  of  "tax-free"  corporation  bond  in- 
terest to  an  individual  citizen  or  resident  of  the  United  States,  when 
ihe  certificate  of  ownership  filed  does  not  claim  exemption; 

(c)  or  making  payments  of  domestic  corporation  dividends 
and  any  domestic  corporation  bond  interest  (whether  bonds  are  "tax- 
free"  or  not)  to  a  foreign  corporation  not  engaged  in  business  or  trade 
in  the  United  States  and  not  having  an  office  or  place  of  business  in 
this  country, 


80  THE    INCOME   TAX 

will  be  required  to  make  return  and  pay  the  tax  deducted  to  the 
Collector  of  Internal  Revenue  of  the  district  in  which  such  "with- 
holding agent"  has  his  or  its  principal  place  of  business. 

In  the  case  of  payment  of  bond  interest  they  must  require  the  til- 
ing of  ownership  certificates  in  one  of  the  several  forms  provided,  and 
they  must  make  both  monthly  and  annual  returns  to  the  Collector. 
In  regard  to  other  payments  annual  returns  will  be  filed. 

For  neglect  or  refusal  to  file  such  a  return  of  tax  deducted  and 
withheld  at  the  source  the  person,  corporation  or  partnership  under 
liability  to  do  so  is  subject  to  fine  and  to  an  increase  of  the  amount  of 
tax  by  50  per  cent. 

Every  person,  corporation  or  partnership  making  any  payment 
subject  to  deduction  of  the  tax  at  the  source,  as  hereinbefore  ex- 
plained, should  write  to  the  Collector  of  Internal  Revenue,  state  the 
kind  of  payments  made,  and  request  the  forwarding  of  official  f<vms 
of  ownership  certificates  and  returns. 

156.— USE  OF  OWNERSHIP  AND 
OTHER  CERTIFICATES. 

Various  forms  of  ownership  certificates  and  other  certificates 
have  been  provided  for  the  use  of  those  in  receipt  of  income.  They 
were  issued  under  the  law  before  recent  amendment  and  may  be 
slightly  altered  during  administration  of  the  law  as  amended;  how- 
ever, in  general  the  certificates  w\\\  be  used  as  follows  : 

Form  1000 — Ownership  certificate  in  which  exemption  is  not 
claimed.  To  be  used  by  individuals,  citizens  or  residents  of  the  United 
States,  with  coupons  or  interest  orders  when  collecting  the  interest 
paid  upon  corporation  bonds. 

Form  1000  B — Ownership  certificate  in  which  exemption  is  claim- 
ed. To  be  used  by  individuals,  citizens  or  residents  of  the  United 
vStates,  with  coupons  or  interest  orders  when  collecting  interest  paid 
upon  corporation  bonds. 

Form  1001 — Ownership  certificates  to  be  used  by  domestic  firms, 
corporations  or  organizations,  the  income  of  which  is  not  subject  to 
deduction  of  tax  at  the  source.  This  certificate  is  to  be  used  in  col- 
lecting interest  paid  upon  corporation  bonds.  It  has  the  effect  of 
a  certificate  claiming  exemption. 

Form  1002 — Certificate  to  be  used  in  lieu  of  owner's  certificate  by 
a  bank  or  other  collecting  agency  in  collecting  interest  paid  upon  cor- 
poration bonds,  when  such  bank  or  othe"  agency  has  purchased  or 


THE   INCOME   TAX  81 

accepted  for  collection  from  individuals  coupons  or  interest  orders 
that  were  not  accompanied  by  certificates  signed  by  such  individual 
bondholders.  The  use  of  this  certificate  (1002)  has  the  effect  of  a  cer- 
tificate claiming  exemption  as  far  as  the  paying  corporation  is  con- 
cerned, but  it  makes  the  bank  or  other  collecting  agency  using  it 
liable  for  the  return  and  payment  of  the  normal  tax  of  2  per  cent  upon 
the  interest  represented  by  coupons  or  interest  orders  so  handled. 

Form  1004 — Ownership  certificate  to  be  used  by  non-resident 
alien  individuals  with  coupons  or  interest  orders  when  collecting  in- 
terest paid  upon  domestic  bonds.  This  is  not  an  exemption  certifi- 
cate. It  is  merely  an  identification  ownership  certificate  and  the  nor- 
mal tax  of  2  per  cent  must  be  withheld  from  any  payment  thus  identi- 
fied. 

Forms  1015  and  1019 — Certificates  in  lieu  of  ownership  certifi- 
cates by  which  a  fiduciary  in  receipt  of  bond  interest  payments  be- 
longing to  a  beneficiary  for  whom  he  acts  either  does  or  does  not  take 
over  liability  as  withholding  agent.  The  use  of  Form  1015  does  and 
the  use  of  Form  1019  does  not  release  the  interest-paying  corporation 
from  withholding  liability. 

Forms  1058  and  1059 — Substitute  certificates  used  by  a  collecting 
agent  and  substituted  for  certificates  signed  by  the  owners  of  the 
bonds.  If  exemption  is  claimed  by  the  owner  of  the  bonds  and  at  the 
same  time  it  is  not  desired  to  disclose  ownership  to  the  paying  cor- 
poration, the  collecting  agent  may  forward  directly  to  the  office  of  the 
Commissioner  of  Internal  Revenue  at  Washington  the  certificate 
signed  by  the  owner  of  the  bonds  and  may  then  transmit  the  coupons 
or  interest  orders  for  payment  accompanied  by  his  own  substitute 
certificate  on  Form  1058,  such  substitute  certificate  on  Form  1058  be- 
ing received  by  the  interest-paying  corporation  as  an  exemption  cer- 
tificate. Form  1059  is  used  in  the  same  way,  except  that  it  is  the  sub- 
stitute certificate  form  to  be  iorwarded  with  the  coupons  or  interest 
orders  when  the  owner  does  not  claim  exemption.  Form  1059  does 
not  release  the  interest-paying  corporation  from  liability  to  withhold 
the  tax. 

Form  1071 — An  exemption  certificate  for  the  use  of  responsible 
banks  or  bankers,  either  foreign  or  domestic  in  behalf  of  non-resident 
owners  of  stocks  and  bonds  of  foreign  corporations,  when  payments 
are  made  in  the  United  States. 

Form  1078 — Certificate  of  residence  to  be  filed  by  an  alien  with 
withholding  agents  for  the  purpose  of  gaining  the  status  of  a  resident 


82  THE    INCOME   TAX 

alien  when  otherwise  the  individual's  status  would  be  that  of  a  non- 
resident alien. 

Form  1086 — Certificate  to  be  filed  with  withholding  agent  by 
foreign  corporations,  etc.,  which  have  an  office  or  place  of  business  in 
the  United  States,  so  that  the  tax  upon  bond  interest  and  dividends 
from  domestic  securities  will  not  be  withheld  as  in  the  case  of  corpor- 
ations having  no  office  or  place  of  business  in  this  country. 

Form  1087 — Certificate  to  be  used  to  disclose  the  actual  owner- 
ship of  stock  when  the  record  owner  is  other  than  the  actual  owner. 

157.— ONLY  2  PER  CENT  WITHHELD. 

With  the  two  income  tax  acts  (Acts  of  September  8,  1916  and  Act 
of  October  3,  1917)  in  effect  the  individual  who  is  a  citizen  or  resident 
of  the  United  States  is  subject  to  two  normal  taxes,  at  the  rate  of  2 
per  cent  for  each  tax.  The  law  provides,  however,  that  the  deduction- 
at-the-source  requirements  shall  not  apply  to  the  War  normal  tax 
imposed  by  the  Act  of  October  3,  1917  until  January  1,  1918,  and  that 
even  thereafter  deduction  at  the  source  from  the  income  of  indivi- 
duals shall  not  be  at  a  rate  higher  than  2  per  cent.  The  remainder  of 
the  normal  tax  is  to  be  returned  and  paid  by  the  person  receiving  the 
income.  This  does  not  affect  non-resident  alien  individuals  because 
they  are  not  subject  to  the  War  normal  tax;  and  it  affects  individuals 
who  are  citizens  or  residents  of  the  United  States  only  so  far  as  their 
income  from  interest  upon  "tax-free"  corporation  bonds  is  concerned. 

158.— INFORMATION  AT  SOURCE. 

The  provisions  calling  for  information  at  the  source  are  practi- 
cally all  new.  They  are  taken  up  with  respect  to  the  different  kinds 
of  payment  affected : — 

— 1.— 

Corporations  To  Report 
Dividend  Payments. 

Every  corporation,  when  required  to  do  so  by  the  Commissioner 
of  Internal  Revenue,  must  make  a  statement,  under  oath,  of  its  pay- 
ment of  dividends,  whether  such  payment  is  made  in  cash  or  its  equi- 
valent or  in  stock.  The  statement  must  disclose  the  name  and  ad- 
dress of  each  stockholder,  the  number  of  shares  owned  by  each,  and 
the  years  in  which  the  dividends  were  earned,  with  the  amounts  be- 
longing to  the  several  years  stated.  This  report  should  be  made, 


THE   INCOME  TAX  83 

when  required,  on  an  official  form  to  be  obtained  from  the  Collector 
of  Internal  Revenue. 

—2.— 

Brokers  To  Report  On 
Customers'  Dealings. 

Every  person,  corporation,  partnership  or  association,  doing  busi- 
ness as  a  broker  on  any  exchange  or  board  of  trade  or  similar  place  of 
business,  must,  when  required  to  do  so  by  the  Commissioner  of  In- 
ternal Revenue,  make  a  statement  under  oath  regarding  the  transac- 
tions of  customers.  This  statement  must  disclose  the  name  of  each 
customer  and  all  the  details  of  his  profits  or  losses  and  such  other  in- 
formation as  the  Commissioner  may  require.  The  report  should  be 
made,  when  required,  on  an  official  form  to  be  obtained  from  the  Col- 
lector of  Internal  Revenue. 

»  Corporations  to  Report 

Bond  Interest  Payments. 

Every  corporation  is  required  to  report,  under  oath,  every  pay- 
ment of  interest  upon  its  bonds,  regardless  of  the  amount  paid.  The 

statute  itself  requires  that  this  report  be  made ;  the  duty  of  making 
the  report  is  not  left  to  the  pleasure  of  the  Commissioner.  The  state- 
ment must  show  the  amount  of  interest  paid  each  individual,  partner- 
ship or  corporation  and  the  name  and  address  of  each.  It  must  also 
be  made  on  an  official  form  to  be  obtained  from  the  Collector  of  In- 
ternal Revenue. 


Report  Required  On 
Foreign  Collections. 

A  report,  under  oath,  is  also  required  by  law  in  the  case  of  the 
collection  of  foreign  items  of  income,  regardless  of  the  amount,  as 

follows  : 

The  report  must  be  made  by  every  person,  partnership,  corpora- 
tion or  association,  undertaking  the  collection  as  a  matter  of  business 
or  for  profit,  by  means  of  coupons,  checks  or  bills  of  exchange,  of  (a) 
interest  paid  upon  the  bonds  of  foreign  countries,  (b)  interest  paid 
upon  the  bonds  of  foreign  corporations,  and  (c)  dividends  paid  upon 
the  stock  of  foreign  corporations. 

The  report  must  give  the  name  and  address  of  each  recipient  of 
such  income  (whether  such  recipient  be  an  individual,  partnership  or 


84  THE   INCOME   TAX 

corporation),  the  character  of  the  income  and- the  amount  collected 
for  each. 

Every  person,  partnership  or  corporation  undertaking  as  a  matter 
of  business  or  for  profit  the  collection  of  the  above  described  foreign 
items  must  first  obtain  a  license  from  the  Government.  Application 
for  this  license  should  be  made  to  the  local  Collector  of  Internal  Rev- 
enue. The  undertaking  of  such  collections  without  having  first  ob- 
tained a  license  is  a  serious  offense,  punishable  by  a  fine  not  exceed- 
ing $5,000,  or  by  imprisonment  for  not  more  than  a  year,  or  both. 

— 5.— 

General  Information 
On  Other  Payments. 

Provision  having  been  made,  according  to  the  preceding  para- 
graphs, for  reports  relative  to 

(1)  Dividend  payments, 

(2)  Transactions  through  brokers. 

(3)  Bond  interest  payments,  and 

(4)  Foreign  collections, 

there  remain  other  payments  to  be  taken  care  of. 

The  law  provides  that  any  such  other  payment  of  income  of  a 
fixed  or  determinable  character,  of  $800  or  more  in  any  taxable  year, 
must  be  reported.  And  in  this  case  the  obligation  to  make  such  re- 
port is  imposed  by  the  statute  and  not  left  to  the  pleasure  of  the  Com- 
missioner of  Internal  Revenue. 

Every  individual,  partnership,  corporation  or  association  making 
such  payments  to  another  individual,  partnership,  corporation  or  as- 
sociation, must  make  a  report,  or  return,  under  oath,  to  the  local  Col- 
lector of  Internal  Revenue,  provided  the  total  paid  to  any  one  recipi- 
ent within  the  year  is  $800  or  more.  (It  must  be  understood,  in  this 
connection,  that  the  four  kinds  of  payments  described  under  preced- 
ing headings  and  enumerated  immediately  under  this  heading  are  not 
to  be  included  in  this  report.) 

The  report  must  show  the  name  and  address  of  each  recipient, 
the  character  of  the  income  and  the  amount  paid  each.  It  must  be 
made  on  an  official  form  to  be  obtained  from  the  Collector  of  Internal 
Revenue.  The  liability  to  make  this  report  attaches  to  lessees  or 
mortgagors  of  real  or  personal  property,  trustees  acting  in  any  trust 
capacity,  executors,  administrators,  receivers,  conservators,  and  em- 
ployers— also  all  persons,  firms  or  corporations  paying  interest  other 
than  bond  interest. 


THE    INCOME   TAX  85 

159.— CERTAIN  REPORTS  REQUIRED  BY  LAW, 
OTHERS  AS  DEPARTMENT  DEMANDS. 

The  provisions  of  the  law  with  respect  to  information  at  the 
source  having  been  discussed  above  under  five  separate  headings, 
attention  is  called  to  the  fact  that  certain  reports  are  required  by  law 
and  others  as  the  Commissioner  of  Internal  Revenue  may  ask  for 
them.  All,  when  made,  must  conform  to  the  regulations  made  by  the 
Department.  These  regulations  had  not  been  made  when  this  book 
went  to  press  but  the  official  forms  obtained  from  the  Collector  of  In- 
ternal Revenue  will  show  what  must  be  reported  and  when  the  re- 
port must  be  filed.  The  reports  discussed  under  headings  No.  1  and 
No.  2,  above,  are  to  be  made  when  required  by  the  Commissioner ; 
those  discussed  under  headings  No.  3,  No.  4  and  No.  5  are  required  by 
law. 

—HOW  TO  OBTAIN  OFFICIAL 
FORMS   FOR  REPORTS. 

All  official  forms  for  reports  are  to  be  obtained  from  the  local 
Collector  of  Internal  Revenue.  The  forms  not  having  been  provided 
when  this  book  went  to  press,  the  numbers  of  them  are  not  known. 
However,  they  may  be  obtained,  when  provided  by  the  Department, 
by  personal  or  written  application,  making  reference  to  report  to  be 
made  under  one  or  more  of  the  following  headings  : 

(a)  Corporation  dividend  payments. 

(b)  Brokerage  business. 

(c)  Bond  interest  payments. 

(d)  Foreign  Collections. 

(e)  Payments  aggregating  $800  or  more  to  one  recipient 
and   not    including    dividends,    business    transacted    through 
brokers,  bond  interest  payments  or  foreign  collections. 

161.— PENALTIES  FOR  FAILURE  TO  REPORT 
OR  MAKING  FALSE  REPORT. 

The  penalty  for  failure  or  refusal  to  make  a  report  of  information 
as  required  by  law  and  as  outlined  above  is  a  fine  of  not  less  than  $20 
nor  more  than  $1,000. 

The  penalty  for  making  a  false  report  is  a  fine  of  not  more  than 
$2,000,  or  imprisonment  for  hot  more  than  one  year,  or  both. 


86  THE   INCOME   TAX 

162.— INDEFINITE  INCOME  NEED 
NOT  BE  REPORTED. 

The  law  requires  that  in  the  case  of  payments  aggregating 
$800  or  more  a  year  to  one  recipient  reports  be  made  only  with  re- 
spect to  income  which  is  of  a  fixed  or  determinable  character.  Income 
in  the  form  of  rent  and  salaries,  and  of  interest  other  than  hond  in- 
terest, is  of  such  fixed  and  periodical  character;  but  the  royalties  paid 
on  a  mine  or  oil  well,  or  from  the  use  of  a  patent  or  sale  of  a  copy- 
righted book,  and  the  commissions  paid  salesmen  are  of  a  different 
character.  Dependent  for  amount  upon  the  extent  of  operations  or 
the  business  done,  they  are  indefinite  and  need  not  be  included  in  a  re- 
port of  information  from  the  source. 


THE    INCOME   TAX  87 


CHAPTER  XII 


THE  INCOME  TAX 


ESTATES  AND  FIDUCIARIES 
UNDER  THE   LAW 


163.— CERTAIN  ESTATES  TAXABLE. 

The  income  tax  law  provides  that  a  return  shall  be  made  and  tax 
paid  by  estates  in  certain  circumstances  and,  when  the  circumstances 
of  administration  make  an  estate  amenable  to  the  requirements  of  the 
statute,  such  estate  virtually  has  the  status  of  a  taxable  individual. 
The  executors,  administrators,  trustees  or  other  person  or  persons  act- 
ing- in  the  fiduciary  capacity,  are  made  responsible  for  filing  the  return 
and  paying  the  tax,  under  all  the  penalties  that  apply  in  the  case  of  in- 
dividuals. 

164.— ESTATE  DURING  SETTLEMENT. 

The  law  provides  that  the  "income  received  by  estates  of  deceased 
persons  during  the  period  of  administration  or  settlement  shall  be  sub- 
ject to  the  normal  and  additional  tax  and  taxed  to  the  estates." 

In  such  a  case  the  estate  is  treated  as  an  entity.  A  return  must  be 
made,  although  such  return  need  not  be  signed  by  more  than  one  of 
the  persons  in  charge  of  the  estate  as  executors,  administrators,  or  in 
other  fiduciary  capacity. 

The  estate  reports  its  income  just  as  an  individual  would  do,  and 
makes  its  deductions  as  far  as  such  deductions  are  properly  chargable 
against  the  income  of  the  estate  for  the  year  in  which  the  return  is 
made.  It  must  not  be  understood,  however,  that  those  expenses  which 
should  be  charged  against  the  principal  of  an  estate  are  allowable  as 
deductions.  By  the  latter  are  meant  such  expenses  as  costs  in  court, 


SB  THE    INCOME   TAX 

counsel  fees,  the  fees  or  commissions    of   executors,  and  '  similar    ex 
penses — the  Treasury  Department  has  repeatedly  held  that  such  ex- 
penses are  to  be  charged  against  the  principal  of  the  estate  and  can 
not  be  deducted  in  a  return  filed  by  the  estate. 

165.— TRUST  ESTATES. 

The  law  also  provides  that  "income  of  estates  or  any  kind  of  prop- 
erty held  in  trust,  including  such  income  accumulated  in  trust  for  the 
benefit  of  unborn  or  unascertained  persons,  or  persons  with  contingent 
interests,  and  income  held  for  future  distribution  under  the  terms  of 
the  will  or  trust  shall  be  likewise  taxed." 

Any  estate  coming  within  the  above  provision  must  make  a  return 
just  as  an  individual  would  do,  and  must  pay  the  tax  shown  to  be  due, 
both  normal  and  additional. 

166.— INCOME  DISTRIBUTED  IN  PART. 

If  any  part  of  the  income  of  an  estate  is  not  distributed  annually 
or  regularly — that  is,  if  any  part  of  the  income  is  not  distributed  or 
distributable  to  known  beneficiaries — then  the  estate  becomes  a  tax- 
able entity  with  respect  to  that  part  of  the  income  and  must  make  re- 
turn, subject  to  full  assessment  of  tax. 

167.— ESTATES  OF  NON-RESIDENT  ALIENS.  " 

If  the  estate,  which  is  required  to  make  return  and  pay  tax.  under 
the  law  as  above  explained,  is  that  of  a  non-resident  alien,  it  follows 
that  only  the  income  of  such  estate  from  sources  within  the  United 
States  need  be  accounted  for,  also  that  only  deductions  related  to  such 
income  are  allowable. 

168.— EXEMPTION  ALLOWED  ESTATE. 

An  estate  of  a  deceased  citizen  or  resident  of  the  United  'States, 
when  required  to  file  return,  is  allowed  to  claim  the  benefit  of  a  speci- 
fic exemption  of  $3,000. 

An^  estate  of  a  deceased  non-resident  alien  is  not  allowed  any 
specific  exemption. 

169.— AMOUNT  OF   INCOME  REQUIRING 
RETURN  TO  BE  FILED. 

The  amount  of  net  income  that  determines  the  question  of  an 
estate's  liability  to  file  a  return  as  a  taxable  entity  is  $3,000,  and  this 
applies  to  estates  both  of  citizens  or  residents  of  the  United  States 


THE    INCOME   TAX  89 

and  of  non-resident  aliens.  Although  the  estate  may  otherwise  come 
within  the  provisions  of  law  making  it  a  taxable  entity,  it  does  not 
have  to  file  return  and  pay  tax  unless  its  net  income  for  the  tax  year 
amounts  to  $3,000  or  more. 

170.— WHEN  DECEDENT  DIES 
DURING  TAX  YEAR. 

Under  authority  of  paragraph  (g)  of  Section  9  of  the  Act  of  Sep- 
tember 8,  1916,  the  Treasury  Department  has  held  that  a  return  must 
be  filed  by  an  executor  or  administrator  in  behalf  of  a  person  who 
has  died  during  the  year,  if  that  person  had  during  the  year  from 
January  1  to  the  date  of  his  death  a  net  income  of  $1,000  or  more  (in 
case  of  a  single  person)  or  $2,000  or  more  (in  case  of  a  married 
person).  In  such  a  return  the  full  exemption  that  would  be  allowed 
the  decedent  were  he  living  at  the  end  of  the  year  can  be  claimed,  ac- 
cording to  whether  such  person  was  single,  married  or  the  head  of  a 
family  on  the  date  of  death.  The  executor  or  administrator  is  made 
liable  for  the  filing  of  the  return  and  payment  of  the  tax. 

This  return  is  distinct  from,  and  must  not  be  confused  with,  any 
return  of  income  which  may  subsequently  be  required  in  behalf  of  the 
estate  as  an  entity  should  the  estate  come  within  the  provisions  of 
law  fixing  liability  for  a  return  in  its  behalf.  And  it  is  possible  that 
both  returns  may  have  to  be  filed  for  the  same  year.  Such  would  be 
the  case  were  the  decedent's  net  income  for  the  year  prior  to  his 
death  $1,000  or  more  (in  the  case  of  a  single  person)  or  $2,000  or  more 
(in  the  case  of  a  married  person),  and  were  the  estate  of  the  character 
to  make  it  a  taxable  entity  and  in  receipt  of  a  net  income  for  the  re- 
mainder of  the  year  amounting  to  $3,000  or  more. 


90  THE    INCOME   TAX 


CHAPTER  XIII 


THE  INCOME  TAX 


ON  CORPORATIONS 


A  great  many  of  the  instructions  applicable  to  the  affairs  of  an 
individual  can  also  be  applied  to  the  income-tax  problems  that  con- 
front every  corporation.  It  is  therefore  suggested  that  when  inform- 
ation is  desired  on  any  point,  and  when  the  subject  is  found  not  to 
have  been  specially  covered  in  instructions  given  for  the  guidance  of 
corporations,  in  particular,  the  taxpayer  consult  the  index  for  refer- 
ence to  the  subject  in  the  instructions  given  individuals.  In  other 
words,  numerous  general  requirements  of  the  law  and  of  the  regula- 
tions of  the  Treasury  Department  are  common  to  the  affairs  of  both 
corporations  and  individuals.  In  places,  where  it  has  been  regarded 
advisable  for  the  sake  of  clarity,  these  will  be  found  to  have  been  re- 
peated, but  not  always  ;  hence  the  subject  should  be  followed  care- 
fully according  to  the  index. 

171.— WHAT  CONSTITUTES   A  CORPORATION. 

The  language  of  the  law  imposing  a  tax  upon  "every  corporation, 
joint-stock  company  or  association,  or  insurance  company  ***** 
no  matter  how  created  or  organized."  except  those  specifically  ex- 
empted, gives  leeway  for  definition  of  the  status  of  a  taxable  corpor- 
ation. And  here  is  the  Treasury  Department's  definition  (to  be  found 
in  Articles  78  and  79  of  Regulations  No.  33,  issued  under  date  of  Jan- 
uary 5,  1914). 

''Corporation'  or  'corpo  ations,'  shall  be  construed  to  in- 
clude all  corporations,  joint-stock  companies  or  associations,  and 
all  insurance  companies  coming  within  the  terms  of  the  law. 

"It  is  immaterial  how  such  corporations  are  created  or  or- 
ganized. The  terms  'joint-stock  companies'  or  'associations' 


THE    INCOME   TAX       ,  91 

shall  include  associates,  real  estate  trusts,  or  by  whatever  name 
known,  which  carry  on  or  do  business  in  an  organized  capacity, 
whether  organized  under  and  pursuant  to  State  laws,  trust 
agreements,  declarations  of  trust,  or  otherwise,  the  net  income 
of  which,  if  any,  is  distributed,  or  distributable,  among  the  mem- 
bers or  share-owners  on  the  basis  of  the  capital  stock  which  each 
holds,  or,  where  there  is  no  capital  stock,  on  the  basis  of  the  pro- 
portionate share  of  capital  which  each  has  invested  in  the  busi- 
ness or  property  of  the  organization,  all  of  which  joint-stock 
companies  or  associations  shall,  in  their  organized  capacity,  be 
subject  to  the  tax." 

172.— CORPORATIONS   LIABLE. 

Under  the  law  every  corporation,  joint-stock  company  or 
association,  or  insurance  company,  organized  in  the  United  States,  no 
matter  how  organized  or  created,  and  not  specifically  enumerated  as 
exempt,  is  required  to  pay  tax,  upon  total  net  income  received. 

Also  every  corporation,  joint-stock  company  or  association,  or 
insurance  company,  organized  or  existing  under  the  laws  of  a  foreign 
country,  is  required  to  pay  tax  upon  total  net  income  received  from 
all  sources  within  the  United  States. 

Thus  taxable  corporations  may  be  divided  into  the  two  general 
classes — domestic  and  foreign. 

173.— CORPORATION  TAX  RATE. 

The  rate  of  tax  under  the  old  law  (Act  of  September  8,  1916)  is 
2  per  cent  on  total  net  income.  The  rate  under  the  new  law  (Act  of 
October  3,  1917)  is  4  per  cent,  except  that  in  the  computation  at  the 
iatter  rate  credit  is  allowed  for  dividends  from  another  corporation. 
Both  rates  are  in  effect.  The  tax  is  imposed  at  a  flat  rate  in  each  in- 
stance, and  total  tax  liability  is  to  be  ascertained  by  computing  tax 
under  both  laws,  with  special  consideration  of  dividends  received  from 
another  corporation,  as  just  noted  and  as  explained  in  detail  elsewhere 
in  this  book  under  appropriate  heading.  (See  Index).  A  corporation 
is  not  subject  to  the  graduated  additional  tax. 

174.— CORPORATION  TAX  ON 

UNDISTRIBUTED  NET   INCOME. 

A  new  provision  in  the  law,  resulting  from  amendment  by  the 
War  Revenue  Act,  is  that  imposing  a  tax  upon  undistributed  net  in- 
come of  a  corporation  in  certain  circumstances  and  subject  to  specified 
exemptions  and  restrictions. 


92  THE    INCOME   TAX 

This  tax  is  to  be  imposed  at  the  rate  of  10  per  cent  only  when  all 
or  a  part  of  the  net  income  which  has  been  disclosed  by  a  corporation 
in  its  return  of  income  for  the  Calendar  or  its  own  fiscal  year  remains 
undistributed  six  months  after  the  close  of  such  Calendar  or  fiscal 
year.  But  even  then,  not  all  of  such  undistributed  net  income  is  sub- 
ject to  tax.  The  following  exemptions  are  to  be  noted : 

(a)  An  amount  of  such  undistributed  net  income    equal    to    the 
income  tax  paid  by  the  corporation  within  the  year. 

(b)  That   portion   of    such    undistributed   net    income    which    is 
actually  invested  and  employed  in  the  business  or  is  retained 
for  employment  in  the  reasonable  requirements  of  the  busi- 
ness. 

(c)  Amount  invested  in  obligations  of  the  United  States  issued 
after  September  1,  1917. 

With  reference  to  sub-parargraph  (b),  above,  the  Secretary  of  the 
Treasury  is  authorized  to  penalize  a  corporation  by  assessing  this  tax 
at  the  rate  of  15  per  cent,  instead  of  10  per  cent,  if  he  should  find  that 
any  portion  of  the  undistributed  net  income  retained  for  investment 
and  employment  in  the  corporation's  business  is  not  so  employed  or  is 
not  required  for  the  reasonable  needs  of  the  business. 

175.— NO  SPECIFIC  EXEMPTION. 

A  corporation  does  not  enjoy  the  specific  exemption  granted  an 
individual.  However  small  its  net  income,  it  must  pay  a  tax  thereon, 
with  the  exception  that  income  from  Government,  State,  municipal 
and  certain  other  bonds,  and  the  value  of  property  acquired  by  gift, 
bequest  or  descent  is  not  taxable. 

176.— EVERY  CORPORATION. 

"Every  Corporation"  must  pay  the  tax,  says  the  law,  with  the  ex- 
ception of  those  specifically  enumerated  as  exempt  from  tax.  [See 
Chapter  on  "Corporations  Exempt."] 

The  word  "every"  must  be  taken  at  its  literal  meaning. 

177.— WITHOUT  INCOME  MUST  FILE  RETURN. 

Every  corporation,  unless  specifically  exempted  because  of  its 
character,  must  file  a  return,  whatever  the  amount  of  its  net  income 
and  even  though  it  have  no  net  income.  This  means  that  many  cor- 
porations operating  at  a  loss  must  file  returns  and  in  such  returns  set 
forth  all  items  of  gross  income  and  deductions.  Whatever  the  result 
of  the  year's  operations — profit  or  loss — the  return  must  be  filed  just 
the  same,  although,  of  course,  where  there  is  no  net  income  shown 
there  is  no  assessment  of  tax. 


THE    INCOME  TAX  93 


178.— SUBSIDIARY  CORPORATION. 

A  subsidiary  corporation,  maintaining  an  incorporated  organiza- 
tion of  its  own,  is  required  to  file  a  return.  The  regulations  of  the 
Treasury  Department  take  no  account  of  its  relation  to  a  parent  cor- 
poration. If  a  principal  corporation  maintains  several  subsidiary  cor- 
porations, each  is  regarded  as  a  separate  and  distinct  entity  and  each 
must  file  a  return.  This  requirement  is  enforced  even  though  the 
purpose  of  maintaining  the  subsidiaries  be  merely  the  protection  of 
brands  or  trade  names,  and  though  the  parent  corporation  own  all 
of  the  stock  of  the  subsidiary  corporations.  The  return  filed  by  each 
subsidiary  must  be  complete  in  every  detail. 

The  subsidiary  corporation  should  file  its  return  with  the  Col- 
lector of  Internal  Revenue  in  whose  district  it  has  its  principal  ac- 
counting offices  even  though  such  district  may  not  be  the  same  as 
that  in  which  the  parent  corporation  is  required  to  file  return. 

179.— CORPORATION  NOT  COMPLETELY  ORGANIZED. 

A  corporation  which  has  not  succeeded  in  completing  its  organi- 
zation, and  has  transacted  no  business  and  had  no  income,  is  not  re- 
quired to  file  a  return.  This  condition  is  found  in  the  case  of  a  cor- 
poration which  has  applied  for  but  not  received  its  charter  or  which, 
after  the  receipt  of  its  charter,  has  not  taken  the  othei  steps  essential 
to  the  perfection  of  its  corporate  organization.  The  uncompleted 
status  of  the  corporation  should,  however,  be  explained  in  writing  to 
the  Collector  of  Internal  Revenue ;  otherwise  he  will  demand  a  re- 
turn, having  received  information  from  State  authorities  of  the  appli- 
cation for  a  charter. 

180.— NEW  CORPORATION. 

Even  though  a  corporation  has  not  been  in  existence  a  full  year, 
it  must  file  a  return.  This  has  reference  to  new  corporations.  The 
return  should  cover  that  portion  of  the  year  during  which  it  was  en- 
gaged in  business  or  was  in  receipt  of  an  income.  Such  corporation 
may  file  upon  the  basis  of  either  the  calendar  or  its  own  fiscal  year 
[as  is  explained  in  the  case  of  all  corporations  in  special  instructions 
regarding  "Fiscal  Year."] 

181.— DISSOLVED  CORPORATION. 

If  a  corporation  dissolves  during  a  tax  year,  it  must  still  file  a  re- 
turn for  that  part  of  the  tax  year  during  which  it  was  in  existence. 
This  return  may  be  filed  either  at  the  time  of  dissolution  or  liquida- 
tion, or  at  the  customary  time  for  filing  returns — on  or  before  March 
1st. 


94  THE    INCOME  TAX 

182.— RETURN  THOUGH  NO  BUSINESS. 

When  organization  has  been  completed  a  corporation  must  file 
a  return  for  the  year  of  its  organization,  whether  it  has  actually  en- 
gaged in  business  or  not.  And,  as  in  the  case  of  all  corporations,  this 
return  may  be  on  the  basis  of  either  the  calendar  year  or  the  corpora- 
tion's own  fiscal  year.  Generally  such  a  return  is  not  much  more 
than  a  "return  in  blank ;"  however,  the  Treasury  Department  requires 
that  it  be  filed. 

183.— CLOSE  CORPORATION. 

The  so-called  close  corporation — the  family  convenience — organ- 
ized to  hold  property,  is  required  to  file  return  as  any  other  corpora- 
tion. The  primary  purpose  of  this  close  corporation  may  be  merely 
protection  of  property  interests  rather  than  profit-making  from  en- 
gaging in  business,  within  the  commonly  accepted  meaning  of  the 
phrase  "engaging  in  business ;"  nevertheless,  it  is  required  to  file  re- 
turn and  pay  tax  when  any  tax  is  found  to  be  due.  As  hereinbefore 
explained,  neither  profit-making  nor  engaging  in  business  is  the  test 
of  liability  to  file  an  income  tax  return. 

184.— HOLDING  COMPANY. 

A  corporation  which  is  nothing  more  than  a  holding  company, 
organized  and  maintained  to  hold  a  stock  interest  in  another  corpora- 
tion, is  required  to  file  a  return.  As  far  as  the  tax  rate  imposed  by  the 
old  law  (Act  of  September  8,  1916)  is  concerned,  it  is  also  required  to 
pay  tax  on  its  entire  net  income.  That  law  allows  a  corporation  no 
credit  for  income  received  in  the  form  of  dividends  on  the  stock  of 
another  corporation.  It  has,  therefore,  often  happened  that  an  oper- 
ating company,  paying  income  tax  on  entire  net  income,  has  turned 
that  net  income  over  to  a  holding  company  as  a  dividend.  The  holding 
company  has  also  been  required  to  file  return  and  report  as  total  gross 
income  the  amount  of  the  dividend,  provided  it  has  had  no  other  in- 
come, and  against  this  gross  income  it  has  had  few,  if  any,  deductions 
that  it  could  claim,  all  the  expenses  of  the  business  giving  rise  to  the 
income  having  been  charged  off  in  the  return  of  the  operating  com- 
pany. In  return,  the  holding  company  has  distributed  to  its  own 
stockholders  the  income  from  the  business,  but  in  passing  from  the 
business  to  the  actual  owners  that  income  has  borne  the  corporation 
income  tax  twice — once  in  the  assessment  against  the  operating  com- 
pany and  again  in  the  assessment  against  the  holding  company. 

This  will  continue  as  far  as  the  imposition  of  the  2  per  cent  tax  of 
the  old  law  is  concerned ;  but  credit  will  be  given  a  corporation  for 


THE    INCOME   TAX  95 

dividends  received  from  another  corporation  in  the  computation  for 
the  4  per  cent  tax  imposed  by  the  new  law. 

185.— LIMITED   PARTNERSHIP. 

A  limited  partnership  has  been  held  by  the  Treasury  Department 
to  be  a  corporation  within  the  meaning  of  the  Income  Tax  law.  It 
must  make  return  under  the  regulations  applicable  to  corporations 
and  must  pay  tax  when  tax  is  found  to  be  due.  The  limited  partner- 
ship is  regarded  as  an  "association"  subject  to  tax  under  that  provision 
of  the  law  imposing  the  tax  upon  the  net  income  of  "every  corpora- 
tion, joint-stock  company,  or  association,  no  matter  how  created  or 
organized." 

An  individual,  receiving  profits  from  a  limited  partnership  should 
treat  such  profits  the  same  as  dividends  from  a  corporation. 

186.— PRIVATE  BANKS  LIABLE. 

A  private  bank  which  maintains  a  corporate  organization,  elects 
officers  and  distributes  its  earnings  according  to  the  amount  of  capi- 
tal invested  by  its  members  or  owners,  is  under  the  full  income-tax 
liability  of  a  corporation.  It  must  make  return.  Only  when  it  can 
be  shown  that  a  private  bank  is  owned  by  one  man  and  is  not  an  asso- 
ciation within  the  meaning  of  the  Income  Tax  law,  can  release  from 
liability  to  file  return  be  granted. 

187.— CHANGE  OF  NAME. 

While  each  new  corporation  becomes  liable  under  the  law,  the 
Treasury  Department  has  held  that  a  mere  change  in  name  does  not 
constitute  a  new  corporation.  If  the  business  is  continued,  without 
change  in  organization  or  operation  other  than  -the  change  in  name, 
return  should  be  made  for  the  entire  year  in  the  name  of  the  corpora- 
tion at  the  end  of  the  tax  year  and  with  a  notation  on  the  return  re- 
garding the  change  of  name.  However,  when  a  new  corporation  is 
organized  to  take  over  the  property  of  an  old  corporation,  each  cor- 
poration is  required  to  make  a  return  for  that  period  of  the  year  dur- 
ing which  it  had  charge  of  the  business. 

188.— RECEIVER  MUST  MAKE  RETURN. 

Subdivision  C  of  Section  10  of  the  Act  of  September  8,  1916,  as 
amended,  transfers  to  receivers,  trustees  in  bankruptcy,  or  assignees 
operating  the  property  or  business  of  corporations,  all  the  obligations 
imposed  upon  the  corporations  themselves.  They  must  file  returns 
and  pay  the  tax. 


96  THE    INCOME    TAX 

On  this  point  a  sample  ruling  of  the  Treasury  Department  in  an 
official  letter  is  so  specific  that  it  is  deemed  advisable  to  quote  it  in 
full.  The  ruling  is  as  follows  : 

The  fact  that  the  business  and  property  of  a  corporation  are  tem- 
porarily in  the  hands  of  a  receiver  does  not  appear  to  be  material  and 
does  not,  in  the  opinion  of  this  office,  relieve  such  income  from  liability 
to  the  tax,  for  the  reason  that,  under  such  circumstances,  the  corpora- 
tion is  none  the  less  the  beneficiary  of  the  income  arising  and  accru- 
ing. The  ordinary  functions,  privileges  and  benefits  of  the  corporation 
may  be  in  suspense  during  the  period  its  affairs  are  in  charge  of  the  re- 
ceiver, but  the  income  is  none  the  less  the  income  of  the  corporation, 
and  if  there  is  a  net  income  it  is  clearly  taxable,  and  the  custodian  of 
such  income  is  liable  to  the  tax  assessable  thereon.  Therefore,  reply- 
ing to  your  inquiries  you  are  informed : 

(1)  That  the  receiver  of  the  property  of  a  railway  company  is  lia- 
ble for  the  income  tax  on  the  net  income  derived  by  him  for  the  opera- 
tion of  the  property,  even  though  such  net  income  is  used  by  the  re- 
ceiver, under  orders  of  the  court,  in  the  payment  of  the  indebtedness 
of  the  railway  company  incurred  in  part  prior  to  and  in  part  during  the 
year  in  which  the  net  income  was  earned. 

(2)  The  receiver  is  liable  for  the  income  tax  on  the  net  income 
arising  and  accruing  during  his  incumbency,  even  though  such  net  in- 
come is  retained  by  him  pending  orders  of  the  court  as  to  its  disposi- 
tion.   The  fact  that  the  outstanding  current  liabilities,  incurred  in  part 
prior  to  and  in  part  during  the  year  in  which  the  income  was  earned, 
are  greater  or  less  than  the  amount  of  the  net  income,  is  immaterial. 
If  the  earnings  of  the  year  are  in  excess  of  expenses  incurred  in  creat- 
ing the  income,  so  that  net  income  arises  or  accrues,  that  net  income 
is  taxable,  and  the  receiver  is  liable  for  the  tax  imposed  thereon. 

(3)  The  receiver  is  liable  for  the  income  tax  assessable  upon  the 
net  income  arising  and  accruing  during  his  incumbency,  even  though, 
under  orders  of  the  court,  such  net  income  is  turned  over  to  the  rail- 
way company,  the  outstanding  liabilities  of  the  railway  company  hav- 
ing been  satisfied. 

(4)  The  receiver  is  liable  for  the  income  tax  assessable  upon  the 
net  income  arising  and  accruing  during  his  incumbency,  even  though 
such  net  income,  under  orders  of  the  court,  is  used  in  the  payment  of 
interest  on  bonds  of  the  railway  company,  such  interest  having  accrued 
during  the  year  in  which  the  income  was  earned  and  being  in  excess  of 
the  amount  which  the  railway    company,  under    the    income    tax  law, 
would  be  permitted  to  deduct  from  gross  income  in  arriving  at  its  net 
income,  were  it  in  charge  of  the  property  and  making  the  return.     In 
other  words,  for  the  purpose  of  the  income  tax,  a  receiver  in  charge  of 
the  property  and  business  of  a  corporation  must  make  a  return  of  an- 
nual net  income  as  of  and  for  the  corporation,  applying  the  same  rules, 
both  as  to  income  and  deductions,  as  the  corporation  would  apply  were 
it  making  the  return.    For  the  purpose  of  the  income  tax,  the  receiver 
of  corporate  property  acts  for  and  in  the  capacity  of  the  officers  of  the 
corporation. 

(5)  From  the  foregoing  you  will  observe  that,  in  the  opinion  of 
this  office,  a  receiver  in  charge  of  the  business  and  property  of  a  cor- 
poration is  liable  for  the  tax  assessable  upon    the    entire    net    income 
arising  and  accruing  and  of  which  the  corporation  is  the  beneficiary. 

189.— FOREIGN  CORPORATION. 

A  foreign  corporation  is  liable  to  tax  only  upon  net  income  re- 
ceived from  "all  sources  within  the  United  States."  However,  some 


THE   INCOME   TAX  97 

specific  definitions  have  been  provided  by  the  Treasury  Department 
with  respect  to  income  from  within  the  United  States.  The  buying 
and  selling  of  a  product  in  this  country  through  an  agency  or  branch 
office,  or  the  sending  of  a  representative  to  this  country  to  solicit 
business  is  held  to  bring  the  foreign  corporation  within  the  meaning 
of  the  Income  Tax  law. 

Also  the  statute  provides  that  interest  on  bonds  or  notes  of  resi- 
dents of  the  United  States,  and  dividends  from  domestic  corporations 
shall  be  regarded  as  income  from  sources  within  the  United  States. 

The  method  of  ascertaining  the  income-tax  liability  of  a  foreign 
steamship  company  carrying  freight  and  passengers  out  of  this 
country  is  clearly  set  forth  by  the  Treasury  Department  in  the  fol- 
lowing ruling : 

"The  returns  made  by  such  corporations,  for  the  purpose 
of  the  income  tax,  should  include  as  gross  income  the  total 
receipts  of  all  outgoing  business,  whether  freight  or  passen- 
gers. With  the  gross  income  thus  ascertained,  the  ratio  ex- 
isting between  it  and  the  gross  income  from  all  ports,  both 
within  and  without  the  United  States,  should  be  determined 
as  a  basis  upon  which  allowable  deductions  may  be  com- 
puted, the  principle  being  that  allowable  deductions  shall  be 
computed  upon  a  basis  which  recognizes  that  the  income 
arising  and  accruing  from  business  done  in  and  from  this 
country  shall  bear  its  share,  and  no  more,  of  expense,  inci- 
dent to  the  earnings  or  creation  of  such  income,  in  the  ratio 
that  the  gross  income  arising  in  and  from  this  country  bears 
to  the  entire  gross  income  arising  from  business  done  both 
within  and  without  this  country.  In  other  words,  the  net  in- 
come of  a  foreign  steamship  company  doing  business  in  or 
from  this  country,  for  the  purpose  of  the  income  tax  assess- 
able and  payable  to  the  United  States,  will  be  ascertained  by 
deducting  from  the  gross  receipts  from  outgoing  business 
such  a  portion  of  the  aggregate  expenses,  losses,  etc.,  as  such 

I  receipts  bear  to  the  aggregate  receipts  from  all  ports,  except 
that  the  interest  deduction,  after  being  likewise  apportioned, 
shall  be  subject  to  the  limitation  fixed  by  the  law."  (See  in- 
structions relative  to  Interest  Deduction.) 

The  return  of  a  foreign  corporation  should  be  made  by  its  prin- 
cipal branch  in  the  United  States.  If  a  foreign  corporation  has  sev- 
eral branches  of  equal  importance,  it  should  designate  one  of  them  as 
its  principal  branch  and  at  the  same  time  name  the  proper  officers  to 
make  its  return.  Notice  of  this  designation  should  be  filed  with  the 


98  THE    INCOME   TAX 

Collector  of  Internal  Revenue  of  the  district  in  which  the  principal 
branch  has  its  place  of  business. 

A  foreign  corporation  has  the  same  right  as  a  domestic  corpor- 
ation to  make  return  upon  the  basis  of  its  own  fiscal  year  instead  of 
the  calendar  year,  by  complying  with  the  regulations  relating  to  fiscal 
year  returns. 

A  foreign  corporation  also  can  claim  exemption  from  the  income 
tax  if  it  comes  within  the  classes  specifically  enumerated  as  exempt. 

And,  as  in  the  case  of  a  domestic  corporation,  so  in  the  case  of  a 
foreign  corporation,  receivers,  trustees  in  bankruptcy,  or  assignees, 
operating  the  property  or  conducting  the  business,  are  required  to 
make  return  for  the  corporation. 


THE    INCOME   TAX  99 


CHAPTER  XIV 


THE  INCOME  TAX 


CORPORATIONS  EXEMPT 


Certain  corporations  are  specifically  exempted  by  the  law  from 
payment  of  income  tax.  If  exempt,  a  corporation  is  not  required  to 
file  the  return  of  annual  net  income  that  provides  the  basis  of  assess- 
ment of  income  tax. 

It  does  not  follow  from  exemption  from  tax,  however,  that  a  cor- 
poration of  exempt  character  does  not  have  to  give  the  Department 
such  reports  of  information,  or  otherwise,  from  the  source,  as  may  be 
called  for  by  the  Commissioner  of  Internal  Revenue. 

The  question  of  exemption  is  one,  however,  that  has  caused  a 
great  deal  of  trouble  and  certain  difficulties  experienced  in  administra- 
tion will,  for  that  reason,  be  emphasized. 

190.— EXEMPT  CLASSES. 

If  a  corporation  belongs  to  one  of  the  following  classes  it  is  not 
subject  to  the  tax: 

1.  Labor,  agricultural  or  horticultural  organization. 

2.  Mutual  savings  bank  not  having  a  capital  stock  re- 
presented by  shares. 

3.  Fraternal  beneficiary  society,  order,  or  association, 
operating  under  the  lodge  system  or  for  the  exclusive  benefit 
of   the  members  of  a  fraternity   itself   operating   under   the 
lodge  system,  and  providing  for  the  payment  of  life,  sick,  ac- 
cident, or  other  benefits  to  the  members  of  such  society,  or- 
der, or  association  or  their  dependents. 

4.  Domestic  building  and  loan  association  and  co-opera- 
tive banks  without  capital  stock  organized  and  operated  for 
mutual  purposes  and  without  profit. 


I'OO  THE    INCOME   TAX 

5.  Cemetery  company  owned  and  operated  exclusively 
for  the  benefit  of  its  members. 

6.  Corporation  or  association  organized    and    operated 
exclusively  for  religious,  charitable,  scientific,  or  educational 
purposes,  no  part  of  the  net  income  of  which   inures   to   the 
benefit  of  any  private  stockholder  or  individual. 

7.  Business  league,  chamber  of  commerce,  or  board  of 
trade,  not  organized  for  profit  and  no  part  of  the  net  income 
of  which  inures  to  the  benefit   of  any  private  stockholder  or 
individual. 

8.  Civic  league  or  organization  not  organized  for  profit 
but  operated  exclusively  for  the  promotion  of  social  welfare. 

9.  Club  organized  and  operated  exclusively  for  pleasure, 
recreation  and  other  non-profitable  purposes,  no  part  of  the 
net  income  of  which   inures   to   the  benefit   of  any   private 
stockholder  or  individual. 

10.  Farmers'  or  other  mutual  hail,  cyclone,  or   fire   in- 
surance   company,    mutual    ditch     or     irrigation     company, 
mutual  or  co-operative  telephone  company,  or  like  organiza- 
tion of  a  purely  local  character,  the  income  of  which  consists 
solely  of  assessments,  dues  and  fees  collected  from  members 
for  the  sole  purpose  of  meeting  its  expenses. 

11.  Farmers',  fruit-growers',  or  like  association,  organ- 
ized and  operated  as  a  sales  agent  for  the  purpose  of  market- 
ing the  products  of  its  members  and  turning  back   to   them 
the  proceeds  of  the  sales,  less  the  necessary  selling  expenses, 
on  the  basis  of  the  quantity  of  produce  furnished  by  them. 

12.  Corporation   or   association   organized   for   the  ex- 
clusive purpose  of  holding  title  to  property,  collecting  income 
therefrom  and  turning  over  the  entire  amount  thereof,  less 
expenses,  to  an  organization  which  itself  is  exempt  from  in- 
come tax. 

13.  Federal  land  banks  and  national  farm-loan  associa- 
tions, as  provided  in  Section   26   of  the   Federal  Farm  Loan 
Act  of  July  17,  1916. 

14.  Joint  stock  land  banks   as   to   income  derived  from 
bonds  or  debentures  of  other  joint  stock  banks  or  any  Fed- 
eral land  bank  belonging  to  such  joint  stock  land  bank. 

191.— MUST  BE  SURE  OF  EXEMPT  STATUS. 

It  will  not  do  for  the  responsible  officers  of  a  corporation  to  con- 
clude that  their  corporation    is    exempt    unless    they    can    classify    it 


THE    INCOME   TAX  101 

strictly  and  precisely  according  to  the  specific  definitions  outlined 
above.  If  a  corporation  is  merely  similar  in  character  to  one  of  an 
exempt  class,  it  is  not  necessarily  exempt.  The  Treasury  Depart- 
ment, in  passing  upon  the  question  of  exemption,  has  held  to  the 
exact  phraseology  of  the  law.  Inquiry  should,  therefore,  be  made  and 
the  facts  stated,  that  there  may  be  no  trouble. 

192.— PROFIT-MAKING  NOT  THE  TEST. 

A  corporation  is  not  exempt  merely  because  it  is  primarily  not 
organized  and  operated  for  profit.  Organization  for  profit  is  not, 
therefore,  in  general  the  test  of  exemption,  even  though  it  should  be 
applied  with  respect  to  certain  of  the  exempt  classes  as  enumerated 
hereinbefore.  Under  the  law  any  corporation,  no  matter  how  created 
or  organized,  is  subject  to  tax  unless  it  comes  within  the  classes 
specifically  enumerated.  So  the  test  of  exemption  becomes  one  of  ap- 
plying one  of  the  definitions  in  the  statute  to  the  corporation  in  ques- 
tion without  departing  in  any  way  from  the  language  of  the  law  and 
without  guessing  as  to  what  might  have  been  the  unexpressed  intent 
of  Congress. 

193.— SHOULD   PROVE  EXEMPT  STATUS. 

Even  though  the  officers  of  a  corporation  are  themselves  con- 
vinced that  the  corporation  is  exempt,  they  should  file  a  statement  of 
the  character  of  the  corporation  with  the  Collector  of  Internal  Rev- 
enue. This  statement  should  be  in  affidavit  form,  and  should  be  ac- 
companied by  evidence  in  support  of  the  claim  made.  Material  evi- 
dence would  be  a  copy  of  the  corporation's  charter  and  By-laws. 
This,  however,  need  be  done  only  once.  In  the  case  of  a  new  corpora- 
tion it  should  be  done  within  the  time  the  corporation  would  be  re- 
quired to  file  a  return  of  income  were  it  not  exempt.  After  he  has 
considered  the  evidence,  it  becomes  the  duty  of  the  Collector  to  notify 
the  corporation  in  writing  whether  it  is  exempt  or  must  pay  tax.  If 
such  notification  is  not  received,  the  matter  should  be  called  to  the 
attention  of  the  Collector.  As  just  explained,  however,  this  proof 
need  be  offered  only  once ;  it  is  not  necessary  for  the  corporation  to 
claim  exemption  each  year.  Having  once  established  its  exempt 
status,  it  is  free  provided  its  character  remain  the  same. 

194.— EXEMPT   FOREIGN   CORPORATIONS. 

Any  foreign  corporation  with  income  from  sources  within  the 
United  States  has  the  same  rights  with  respect  to  exemption  as  a 
domestic  corporation.  It  should  follow  exactly  the  course  just  out- 
lined. 


102  THE    INCOME   TAX 

195.— AGRICULTURAL  ASSOCIATIONS. 

Time  and  again  exemption  from  tax  has  been  claimed  by  corpora- 
tions engaged  in  agriculture.  This  has  always  been  due  to  a  misun- 
derstanding of  the  law.  Those  agricultural  and  horticultural  associa- 
tions enumerated  as  exempt  have  been  held  to  be  such  associations  as 
fairs  or  public  expositions,  or  like  organizations,  not  themselves  en- 
gaged in  agricultural  or  horticultural  pursuits  but  conducted  for  the 
purpose  of  encouraging  progress  by  the  award  of  prizes  and 
premiums.  In  other  words,  the  agricultural  or  horticultural  associa- 
tion, to  be  entitled  to  exemption,  must  be  public  in  character. 

196.— BUILDING  AND  LOAN  ASSOCIATIONS  (DOMESTIC) 

Among  the  corporations  enumerated  as  exempt  from  tax  are 
domestic  building  and  loan  associations.  The  Treasury  Department 
has  held  a  domestic  building  and  loan  association  to  be  "one  organized 
under  and  pursuant  to  the  laws  of  the  United  States,  or  of  a  State  or 
Territory  thereof,  or  under  the  laws  applicable  to  Alaska  or  the  Dis- 
trict of  Columbia."  But  the  Department  has  also  gone  farther  and 
insisted  that  the  question  of  exemption  from  tax  also  depends  on 
mutuality  in  operation  and  the  distribution  of  profits  and  benefits. 
Therefore,  to  be  entitled  to  exemption,  under  the  Department  ruling, 
an  association  must  not  only  be  "domestic"  but  must  be  so  organized 
and  operated  that  all  the  profits  and  benefits  provided  for  in  the 
articles  of  association  and  by-laws  are  ratably  distributed  among  all 
the  members  "regardless  of  the  kind  of  stock  held,  according  to  the 
amount  of  money  they  have  on  deposit."  And  so  it  is  held  that  the 
issuance  of  different  classes  of  stock  upon  which  different  rates  of  in- 
terest or  dividends  are  guaranteed  or  paid  deprives  an  association  of 
the  right  of  exemption. 

197.— CEMETERY  COMPANIES. 

As  in  the  case  of  corporations  engaged  in  agriculture  so  corpora- 
tions engaged  in  the  operation  of  cemeteries  for  profit  have  claimed 
exemption  because  of  a  misunderstanding  of  the  law.  Exemption,  in 
this  respect,  is  strictly  limited  to  cemetery  companies  organized  and 
operated  exclusively  for  the  mutual  benefit  of  their  members.  A 
cemetery  company  must,  therefore,  be  mutual  in  character. 

198.— SOCIAL  CLUBS. 

As  a  rule,  clubs  are  exempt.  However,  there  are  many  incorpor- 
ated business  enterprises,  styled  clubs,  that  are  not  entitled  to  ex- 
emption. The  test  is  the  plain  language  of  the  law.  The  club  must 


THE    INCOME   TAX  103 

be  operated  exclusively  for  pleasure,  recreation  or  other  non-profit- 
able purpose  and  no  part  of  its  net  income  can  inure  to  the  benefit 
of  any  private  stockholder,  individual  or  member.  Moreover,  it 
should  submit  its  case  to  the  Collector  of  Internal  Revenue  in  the 
form  of  affidavit  and  get  his  opinion  of  its  status. 

199.— SOCIETY  UNDER  LODGE  SYSTEM. 

The  exemption  granted  a  "fraternal  beneficiary  society,  order,  or 
association,  operating  under  the  lodge  system"  is  intended,  according 
to  the  Treasury  Department  ruling,  for  a  society  or  association  "or- 
ganized under  a  charter,  with  properly  appointed  or  elected  officers, 
with  an  adopted  ritual  or  ceremonial,  holding  meetings  at  stated  in- 
tervals, and  supported  by  fees,  dues,  or  assessments." 


J04  THE    INCOME   TAX 


CHAPTER  XV 


THE  INCOME  TAX 


GROSS   INCOME   OF   CORPORATIONS 


The  Income  Tax  law  requires  that  gross  income  be  stated  ia  full 
by  a  corporation.  The  amount  derived  from  each  source  must  be 
stated  and  the  aggregate  ascertained.  Then  from  this  total  of  gross 
income  may  be  subtracted  the  total  of  deductions  allowable,  leaving 
what,  under  the  statute,  is  the  net  income.  It  is,  therefore,  essential 
primarily  that  a  corporation  be  given  to  understand  what  is  expected 
of  it  in  the  statement  of  its  gross  income. 

Certain  rules  have  been  made  by  the  Treasury  Department  for 
determining  the  gross  income  of  a  corporation;  at  times  these  rules 
have  been  adapted  to  the  exigencies  of  certain  cases,  so  from  an  ex- 
perience in  enforcing  them  and  in  handling  the  many  special  cases 
that  have  arisen  a  general  outline  of  the  requirements  of  the  Depart- 
ment can  be  given  here.  However,  cases  requiring  special  attention 
will  continue  to  arise.  It  is  manifestly  impossible  to  lay  down  any  set 
of  rules  to  cover  the  administration  of  a  law  that  comprehends  in  its 
effect  almost  every  conceivable  business  relation  and  condition. 

Briefly  are  outlined  the  requirements  of  law  and  regulation  with 
special  reference  to  certain  well-defined  classes  of  corporations.  Al- 
ways, however,  the  taxpayer,  whether  individual  or  corporation, 
should  bear  in  mind  that  income  in  the  form  of  interest  on  United 
States  bonds  (within  the  limit  with  respect  to  those  issued  after  Sept. 
1,  1917)  and  on  State,  county,  municipal,  school  and  special  assess- 
ment district  bonds  is  exempt  from  tax  and  is  not  to  be  included  in 
any  return  of  income. 

200.— BANKING  CORPORATION. 

The  gross  income  of  a  banking  corporation  consists  of  the  total 
revenue  from  the  operation  of  the  actual  business  of  banking  and 


THE   INCOME   TAX  105 

from  all  other  activities  of  the  corporation.  In  fact  gains  and  profits 
from  every  source,  as  shown  by  the  books  of  the  corporation,  or  bank, 
(excepting  interest  on  the  tax-free  bonds  hereinbefore  referred  to) 
must  be  included  in  the  return  of  the  corporation  for  the  calendar 
year,  or  its  own  fiscal  year. 

Recovery  on  a  Note. 

In  the  case  of  a  bank  the  Treasury  Department  has  ruled  that 
where  a  bad  account,  represented,  for  instance,  by  defaulted  paper, 
has  been  charged  off  and  subsequently  the  amount  has  been  re- 
covered, the  amount  recovered  must  be  included  as  income  for  the 
year  in  which  recovered.  Of  course,  if  the  amount  had  been  charged 
off  to  profit  and  loss  within  the  period  beginning  January  1,  1909,  (the 
incidence  of  the  old  corporation  excise  tax)  and  the  corporation  had 
had  the  benefit  of  a  deduction  on  account  of  "bad  debts,"  it  would 
naturally  follow  that  the  recovery  of  the  money  represented  income 
to  be  included  in  a  return.  The  Department  holds,  however,  that 
even  though  the  amount  was  charged  off  and  disappeared  from  the 
assets  of  the  bank  prior  to  January  1,  1909,  the  recovery  of  the  money 
represents  income  for  the  year  in  which  recovered.  Neither  the  date 
at  which  it  was  charged  off  nor  the  fact  that  the  corporation  did  not 
have  the  benefit  of  a  deduction  of  it,  as  a  bad  debt,  for  income  tax  pur- 
poses, affects  its  character  as  income  for  the  year  in  which  recovered, 
in  the  opinion  of  the  Department. 

A  case  in  point  would  be  as  follows :  A  bank  in  the  year  1908 
held  the  note  of  a  bankrupt  for  $20,000.  As  collection  was  out  of  the 
question  the  amount  was  regarded  as  irrevocably  gone  and  was 
charged  off  as  a  bad  debt.  In  the  year  1917,  the  maker  of  the  note, 
having  rehabilitated  his  affairs,  paid  the  note  as  an  obligation  of 
honor.  In  such  circumstances  the  bank  must  include  the  amount  of 
the  recovery  as  income  for  the  year  1917. 

Federal  Reserve  Dividends. 

Income  from  or  dividends  on  the  stock  of  Federal  Reserve  Banks, 
received  by  member  banks,  is  exempt  from  income  tax  and  need  not 
be  included  by  member  banks  in  their  returns  for  income  tax  pur- 
poses, according  to  a  ruling  in  a  letter  to  the  Governor  of  the  Federal 
Reserve  Board  from  the  Commissioner  of  Internal  Revenue  on  March 
9,  1916.  The  substance  of  the  Commissioner's  ruling  is  as  follows : 

This  office  has  decided  that  the  income  derived  from,  or  dividends 
received  on,  the  stock  of  Federal  Reserve  Banks  is  exempt  from  the  in- 
come tax.  In  other  words,  it  is  held  that  the  exemption  provided  for  in 
the  Federal  Reserve  Act  attaches  to  and  follows  the  dividends  into  the 


106  THE   INCOME   TAX 

hands  of  member  banks  holding  the  Federal  Reserve  Bank  stock. 
Member  banks  will  therefore  be  permitted  to  exclude  from  their  gross 
income,  for  the  purpose  of  the  income  tax,  the  dividends  received  on 
such  stock. 

201.— CONTRACTING  CORPORATION. 

Special  provision  has  been  found  necessary  in  order  to  enable  a 
corporation  engaged  in  the  contracting  business  to  ascertain  its  gross 
income  equitably,  for  the  purpose  of  the  income  tax.  Consequently, 
the  Treasury  Department  has  ruled  that  gross  income  may  be  arrived 
at  upon  the  basis  of  completed  work — according  to  work  finished  and 
paid  for  during  the  year  for  which  the  return  is  made.  This  method 
is  not  imposed  upon  all  contractors,  but  experience  has  shown  that  it 
is  best  in  the  case  of  a  concern  which  has  uncompleted  contracts  that 
run  for  periods  of  several  years.  When  this  method  is  employed,  the 
deductions  of  the  contracting  corporation  are  limited  to  expenses  in 
connection  with  the  completed  jobs  from  which  income  is  reported. 

202.— INSURANCE   CORPORATIONS. 

Corporations  engaged  in  the  insurance  business  have  been  given 
special  instructions  to  fit  the  varying  conditions  with  respect  to  dif- 
ferent kinds  of  insurance  and  peculiar,  in  each  instance,  to  the  opera- 
tions of  the  corporation  along  its  own  line  of  activity. 

In  the  first  place,  and  in  general,  of  course,  the  gross  income  of 
an  insurance  company  consists  of  its  total  revenue  from  the  operation 
of  its  business  and  of  gains  or  profits  from  all  other  sources,  as  shown 
by  its  books,  within  the  year,  calendar  or  fiscal,  for  which  the  return 
is  made.  But  one  rule  without  variation  or  elaboration  cannot  be 
made  to  fit  all  classes  of  the  insurance  business,  so  special  instructions 
are  necessary. 

Life  Insurance. 

A  life  insurance  company  is  allowed  to  omit  from  gross  income 
such  portion  of  any  actual  premium  received  from  an  individual 
policyholder  as  shall  have  been  paid  back  or  credited  to  the  policy- 
holder  or  treated  as  an  abatement  of  his  premium.  Deferred  divi- 
dends, so-called  in  insurance  parlance,  payable  at  a  stated  period,  can 
also  be  omitted  from  gross  income  in  so  far  as  they  represent  a  por- 
tion of  any  actual  premium  received,  such  omission  to  be  with  respect- 
to  the  year  in  which  paid  back,  credited  to  the  policyholder,  or  applied 
as  an  abatement  of  premium.  In  the  case  of  dividends  credited  or  ap- 
portioned annually  to  the  policyholder,  only  the  aggregate  amount 
actually  credited  or  apportioned  during  the  premium-paying  period. 


THE   INCOME   TAX  107 

and  not  any  accretion  thereto,  can  be  omitted.  In  the  case  of  whole- 
life  or  five-year  distribution  policies,  deferred  dividends  may  be 
omitted  from  gross  income  only  to  the  extent  that  they  are  paid  back, 
or  credited  to  the  insured,  or  used  as  an  abatement  of  his  annual 
premiums. 

Mutual  Fire  Insurance. 

A  mutual  fire  insurance  company,  the  members  of  which  are  re- 
quired to  make  premium  deposits  to  provide  for  losses  and  expenses, 
can  omit  from  gross  income  any  portion  of  the  premium  deposits  re- 
turned to  the  members  or  policyholders,  but  must  include,  for  income 
tax,  all  income  received  from  all  other  sources  plus  such  portions  of 
the  premium  deposits  as  are  retained  by  the  company  for  purposes 
other  than  the  payment  of  losses,  expenses  and  for  reinsurance  re- 
serves. Thus,  if  a  mutual  fire  insurance  company  retains  out  of 
moneys  received  on  account  of  assessments  an  amount  in  excess  of 
the  losses,  expenses,  and  reinsurance  reserve  of  any  particular  year, 
such  excess,  plus  any  amounts  received  as  interest,  dividends,  or  from 
any  other  source,  is  regarded  as  net  income,  upon  which  tax  can  be 
assessed  In  other  words,  in  the  case  of  such  an  insurance  company 
the  result  obtained  by  following  the  instructions  of  the  Treasury  De- 
partment is  net  income,  rather  than  gross  income. 

Mutual  Employers'  Liability  Insurance. 

A  mutual  employers'  liability  insurance  company  should  follow 
instructions  given  the  mutual  fire  insurance  company. 

Mutual  Workmen's  Compensation  Ins. 

A  mutual  workmen's  compensation  insurance  company  also 
should  follow  instructions  given  the  mutual  fire  insurance  company. 

Mutual  Casualty  Insurance. 

A  mutual  casualty  insurance  company  should,  likewise,  follow 
instructions  given  the  mutual  fire  insurance  company. 

Mutual  Marine  Insurance. 

A  mutual  marine  insurance  company  is  required  to  include  in  its 
return  the  gross  premiums  collected,  but  is  allowed  in  its  return  to 
claim  deductions  for  amounts  repaid  to  policyholders  on  account  of 
premiums  previously  paid  by  them  and  any  interest  paid  upon  such 
amounts  between  the  time  they  are  ascertained  and  the  time  they  are 
paid. 


108  THE   INCOME   TAX 

203.— RELEASED  INSURANCE  RESERVES. 

An  insurance  corporation,  required  under  State  laws  to  maintain 
certain  specified  reserves  is  allowed  under  the  Federal  Income  Tax 
law  to  deduct  from  the  gross  income  of  any  year  the  net  additions  re- 
quired by  law  to  be  made  to  reserves  during  that  year ;  but  the  cor- 
poration must  return  for  the  purpose  of  the  income  tax  any  amount 
of  released  reserve,  as  such  release  may  occur  from  time  to  time. 

204.— MISCELLANEOUS  CORPORATIONS. 

As  already  explained,  the  income  tax  law  contemplates  that  a  re- 
turn shall  include  income  from  all  sources,  except  from  specifically 
exempted  sources,  and  the  corporation  is  expected  to  comply  with  that 
general  purpose  of  the  statute  in  the  lack  of  special  instructions  which 
it  may  regard  as  necessary  to  fit  its  own  affairs.  In  short,  the  general 
requirement  should  be  borne  in  mind  that  the  gross  income  of  a  cor- 
poration consists  of  the  total  revenue  derived  from  the  operation  of  its 
business  and  property,  together  with  all  amounts  of  income  from 
other  sources,  as  shown  by  its  books  of  account,  except  income  from 
specifically  exempted  sources. 

205.— PROCEEDS  FROM  SALE  OF  STOCK. 

The  proceeds  received  by  a  corporation  from  the  sale  and  issue 
of  its  capital  stock  are  not  income.  On  the  other  hand,  such  proceeds 
constitute  capital  of  the  corporation  and  should  not  be  included  in  a 
statement  of  gross  income.  Likewise,  any  amount  received  in  the 
form  of  an  assessment  on  stock  is  not  income  to  be  returned  for  tax 
by  the  corporation.  Such  an  amount  is  held  to  represent  an  addi- 
tional investment  in  the  stock  of  the  corporation  and  the  transaction 
is  purely  capital  with  respect  to  both  the  corporation  and  the  stock- 
holder. 

Above  or  Below  Par. 

And  it  makes  no  difference  whether  the  stock,  as  originally,  is- 
sued, is  sold  above  or  below  its  par  value.  Neither  the  premium  nor 
the  discount,  with  respect  to  par  value,  has  anything  to  do  with  the 
income  of  the  corporation  for  income  tax  purposes.  The  amount  re- 
ceived for  the  stock  is  strictly  capital  to  the  corporation. 

206.— RECOVERIES  ON  BAD  DEBTS. 

With  respect  to  the  treatment  of  any  amount  recovered  on  a  debt 
charged  off  as  worthless,  the  taxpayer  should  follow  the  general  rul- 
ing explained  in  connection  with  the  gross  income  of  a  bank.  [See 
paragraph  headed  "Banking  Corporation."] 


THE    INCOME   TAX  109 

207.— SINKING  FUND  EARNINGS. 

By  definite  decision  the  Department  has  held  that  in  cases  where- 
in corporations  set  aside  and  place  in  a  sinking  fund  under  the  control 
of  trustees  their  own  bonds  or  the  bonds  of  other  corporations  which 
they  may  own,  the  fund  thus  set  aside  is  an  asset  of  the  corporation, 
and,  in  the  event  of  any  increment  to  that  fund  as  a  result  of  invest- 
ments, such  increment  is  income  to  the  corporation  and  must  be  in- 
cluded in  its  return. 

If  the  trustees,  in  such  a  case,  have  invested  the  amount  of  the 
sinking  fund  reserve  or  any  part  of  it  in  the  bonds  of  the  corporation 
for  which  they  act,  a  situation  has  been  created  which  calls  for  care- 
ful treatment.  The  Department  has  held  that  the  corporation  would 
be  allowed  to  deduct  in  its  return  any  interest  paid  to  the  trustees  on 
its  own  bonds  (provided  the  amount  of  the  interest  thus  paid  did  not 
exceed  the  limit  fixed  by  law)  but  that  at  the  same  time  the  corpora- 
tion would  be  required  to  include  such  amount  of  interest  paid  the 
trustees  in  accounting  for  income  represented  by  the  earnings  of  the 
sinking  fund. 

208.— ROYALTIES  AND  PATENT  RIGHTS. 

The  instructions  applicable  to  the  income  of  individuals  with  re- 
spect to  royalties  and  patent  rights,  or  copyrights,  apply  also  to  the 
income  of  corporations.  [Consult  the  instructions  given  under  appro- 
priate headings  in  connection  with  income  of  individuals.] 

209.— ROYALTIES  FROM  MINES  OR  WELLS. 

Royalties  from  mines  or  from  oil  or  gas  wells  received  by  a  lessor 
corporation  from  a  lessee  operating  concern,  obviously  represent  re- 
turnable income  to  the  lessor  corporation. 

210.— EXCHANGE  OF  CAPITAL  STOCK 

ON  REORGANIZATION  OF  CORPORATIONS. 

As  hereinbefore  explained,  income  received  in  cash,  or  the  equi- 
valent of  cash,  is  subject  to  tax;  and  a  corporation  is  required  to  re- 
turn for  tax  its  income,  gains  and  profits  from  all  sources  except  cer- 
tain specifically  exempted  income. 

The  Treasury  Department  has  defined  "Profit"  as  "difference  be- 
tween the  selling  price  and  the  cost  where  the  selling  price  is  more 
than  the  cost."  This  definition  would  have  to  be  modified,  however, 
to  substitute  "fair  market  price  or  value  as  of  March  1,  1913"  for 
"cost"  in  the  case  of  property  acquired  prior  to  March  1,  1913. 


110  THE   INCOME   TAX 

All  of  which  bears  upon  the  Department's  position  with  respect 
to  the  exchange  of  capital  stock  or  securities  by  which  corporations 
are  reorganized  within  themselves,  or  by  which  two  or  more  corpora- 
tions are  consolidated  or  merged  into  one  general  management  and 
control. 

On  this  point  the  Department  has  at  least  once  changed  its  posi- 
tion, but  its  present  ruling  may  be  taken  from  the  following  official 
letter  issued  by  the  Commissioner  of  Internal  Revenue  on  September 
9,  1916: 

The  present  holding  of  this  office  is  that  in  all  cases  wherein  a  cor- 
poration sells  and  transfers  its  assets  to  another  corporation,  the 
amount  received  by  the  selling  corporation  in  excess  of  the  cost  of  the 
property  sold  will  be  considered  income  to  such  selling  corporation. 
[In  the  case  of  acquisition  of  the  property  by  the  selling  corporation 
prior  to  March  1,  1913,  the  fair  market  price  or  value  of  the  property 
as  of  that  date  must  be  considered  instead  of  cost  in  determining  ex- 
cess, or  gain.] 

If  the  shares  of  stock  received  by  the  selling  corporation  are  dis- 
tributed by  it  to  its  stockholders,  the  amount  so  distributed  in  excess 
of  the  stock  held  by  them  in  the  original  corporation  will  be  considered 
income  to  such  stockholders  and,  for  the  purpose  of  the  super-tax, 
should  be  returned  by  them.  *  *  *  * 

The  selling  corporation  being  taxable  on  the  excess  of  the  stock 
received  over  the  cost  of  the  assets  sold  [or  over  fair  market  price  or 
value  as  of  March  1,  1913,  in  the  case  of  assets  acquired  prior  to  that 
date,]  the  individuals  receiving  the  excess  in  the  form  of  stock  of  the 
purchasing  company  will  not  be  required  to  return  their  respective 
shares  of  such  excess  for  the  purpose  of  the  normal  tax. 

However,  there  may  be  a  sale  of  its  assets  by  a  corporation  to 
another  corporation  for  stock,  share  for  share,  of  like  par  value  and 
with  the  same  assets  supporting  the  stock  of  the  new  vendee  corpora- 
tion as  fixed  the  true  value  of  the  stock  of  the  old  vendor  corporation. 
A  case  in  point  would  be  as  follows  : 

A  corporation  with  an  authorized  capital  stock  of  $500,000,  had  in 
1912  acquired  property  representing  an  investment  of  its  entire  issued 
capital  stock  of  $350,000.  For  good  reason  it  is  decided  to  organize  a 
new  corporation,  also  with  an  authorized  capital  stock  of  $500,000, 
such  new  corporation  to  take  over  the  investment  of  the  old  corpora- 
tion, in  consideration  of  the  issue  of  $350,000  of  its  capital  stock,  such 
stock  of  the  new  corporation  to  be  distributed  among  the  stock- 
holders of  the  old  corporation,  according  to  their  individual  interests 
in  the  old  corporation.  After  the  transfer  of  assets  and  the  comple- 
tion of  the  transaction  the  old  corporation  would  be  dissolved. 

In  such  a  case  the  Treasury  Department  has  held  that,  the  shares 
of  stock  authorized  and  issued  being  the  same  as  to  both  corporations, 
and  there  being  no  consideration  to  the  old  corporation  for  its  assets, 
other  than  the  $350,000  par  value  of  the  new  corporation's  stock,  an 


THE    INCOME   TAX  111 

amount  exactly  equal  to  the  par  value  of  the  old  company's  stock  out- 
standing, no  profit  subject  to  tax  would  accrue  to  the  old  corporation. 
Such  an  exchange  of  stock  would  not  constitute  a  stock  dividend  and, 
being  on  the  basis  of  issuance,  share  for  share,  of  like  par  value,  would 
not  result  in  any  taxable  income  to  the  stockholders  of  the  old  cor- 
poration. The  stock,  both  authorized  and  issued,  being  in  both  cases 
of  like  par  value  and  being  predicated  upon  exactly  the  same  assets, 
the  transaction  would  result  in  no  gains,  profits  or  income  to  either 
the  old  corporation  or  its  stockholders. 

But  if  subsequently  the  stockholders  of  the  new  corporation 
(who  prior  to  the  transaction  were  the  stockholders  of  the  old  cor- 
poration) should  sell  their  stock  in  the  new  corporation,  they  would 
be  required  to  return  for  tax  any  amount  received  for  the  stock  of  the 
new  corporation  in  excess  of  the  cost  of  the  same  number  of  shares 
of  stock  of  the  old  corporation  (if  the  stock  of  the  old  corporation 
was  acquired  on  or  after  March  1,  1913),  or  in  excess  of  the  fair 
market  price  or  value  of  the  stock  of  the  old  corporation  as  of  March 
1,  1913,  (if  the  stock  of  the  old  corporation  was  acquired  prior  to 
March  1,  1913.)  In  other  words,  the  investment  in  such  a  case  would 
be  regarded  as  having  its  beginning  in  the  acquisition  of  the  stock  of 
the  old  corporation. 

211.— GOOD  WILL. 

While  the  Treasury  Department  has  held  that  the  element  of 
"Good  will"  is  so  intangible  as  not  to  enter  into  the  calculation  of  the 
value  of  a  corporation's  assets,  and  as  subject  to  neither  depreciation 
nor  appreciation,  still  it  may  be  a  considerable  factor  in  the  case  of  a 
sale  of  assets  by  one  corporation  to  another,  effected  by  the  selling 
corporation  taking  for  distribution  among  its  stockholders  stock  of 
the  purchasing  corporation.  In  a  case  where  the  assets  of  the  selling 
corporation  were  acquired  prior  to  March  1,  1913,  the  value  of  the 
assets  of  that  date  must  be  ascertained.  Experience  has  shown  that 
the  most  nearly  equitable  computation  in  such  circumstances  is  based 
upon  the  fair  market  price  or  value  of  the  selling  corporation's  stock 
on  March  1,  1913,  and  certainly  in  the  determination  of  such  price  or 
value,  in  many  instances,  good  will  (business  standing)  was  a  factor 
even  though  it  was  an  intangible  asset  at  the  time. 

212.— COMPROMISE  OF   INDEBTEDNESS. 

The  compromise  of  indebtedness  creates  income  to  be  returned 
for  tax,  according  to  the  ruling  of  the  Department.  In  this  respect 


112  THE    INCOME   TAX 

the  following  official  letter  issued  by  the  Commissioner  of  Internal 
Revenue  on  July  10,  1915,  is  self-explanatory: 

This  office  is  in  receipt  of  your  letter  of  the  30th  ultimo  in  which 
you  submit  for  ruling  the  following  proposition: 

"A  company  which  has  been  unable  to  pay  any  interest  on  its  bond- 
ed indebtedness  for  some  years  proposes  to  settle  that  indebtedness, 
the  creditors  to  reduce  the  face  of  the  bonds  by  $100,000  as  an  induce- 
ment for  the  raising  of  $100,000  in  cash. 

"By  this  process  the  apparent  financial  condition  of  the  debtor  com- 
pany is  improved  by  $100,000,  not  through  any  earnings  but  by  effecting 
a  settlement  with  its  creditors  by  which  $200,000  of  its  bonds  are  can- 
celled at  a  cost  to  it  of  $100,000  in  cash,  namely  at  50  cents  on  the 
dollar," 

In  reply  to  your  inquiry  as  to  whether  such  a  compromise  of  in- 
debtedness is  taxable  as  income,  you  are  informed  that  while  in  fact  the 
earnings  of  the  corporation  are  in  no  wise  increased  by  this  compro- 
mise, the  liabilities  are  reduced  and  to  that  extent  the  corporation 
gains  in  its  net  worth. 

In  somewhat  similar  cases  to  this,  in  which  the  creditor  has  for- 
given the  debt  of  the  debtor,  this  office  has  held  that  the  amount  of  the 
debt  forgiven  constitutes  income.  In  this  particular  case,  in  the  opinion 
of  this  office,  the  difference  between  the  amount  realized  by  the  corpor- 
ation when  the  bonds  were  sold  and  the  amount  which  it  now  is  re- 
•  quired  to  pay  upon  the  redemption  of  the  same,  constitutes  income, 
which  income  may  be  prorated  over  the  period  elapsing  between  the 
•date  of  the  bond  issue  and  the  date  of  their  payment,  and  that  portion 
of  such  income  apportioned  to  the  years  subsequent  to  January  1,  1909, 
will  be  returned  as  taxable  income  for  the  year  in  which  the  bonds  are 
redeemed. 

213.— INTEREST  ON  BONDS  WITH  TAX-FREE  GUARANTY. 

A  corporation  which  owns  bonds  containing  a  guaranty  that  the 
interest  paid  on  them  shall  be  free  of  tax  to  the  holder  is  not  relieved 
of  liability  to  include  such  interest  in  its  own  return.  The  law  does 
not  provide  for  transfer  of  tax  liability  to  the  corporation  which  has 
issued  the  bonds.  In  other  words,  the  Government  does  not  recognize 
the  guaranty  in  the  bond  but  insists  that  the  corporation  receiving  the 
interest  shall  include  the  amount  in  its  return  the  same  as  any  other 
amount  of  interest  received. 

It  is  well,  therefore,  for  any  corporation  owning  such  bonds  and 
receiving  interest  on  them  to  realize  that,  absolutely  without  regard 
to  the  covenant  in  the  bond,  the  full  amount  of  the  interest  must  be 
included  in  a  return  of  gross  income.  Any  adjustment,  by  which  the 
holder  of  the  bonds  may  seek  the  benefit  of  the  covenant,  must  be  be- 
tween the  holder  of  the  bonds  and  the  corporation  which  has  issued 
them. 

214.— PROFIT  FROM  SALE  OF  CAPITAL  ASSETS. 

The  entire  profit  or  gain  realized  from  the  sale  or  other  disposi- 
tion of  capital  assets  must  be  included  in  a  return  of  income.  This 
has  reference  to  all  property,  both  real  and  personal.  With  respect  to 


THE    INCOME   TAX  113 

the  methods  of  ascertaining  the  gain  from  a  sale  or  other  disposition 
of  real  property  and  that  from  a  sale  or  other  disposition  of  personal 
property,  however,  there  are  some  points,  not  exactly  of  difference, 
but  rather  of  peculiar  application  to  one  or  the  other  kind  of  property. 
[See  instructions  beginning  with  paragraph  "Sale  of  Property"  in 
instructions  to  individuals.] 

Acquired  on  or  After  Mar.  1,  1913. 

With  respect  to  all  property,  both  real  and  personal,  acquired  on 
or  after  March  1,  1913,  the  gain  to  be  returned  is  the  difference  be- 
tween the  selling  price  and  cost  where  the  selling  price  is  more  than 
the  cost. 

Acquired  Prior  to  Mar.  1,  1913. 

With  respect  to  all  property,  both  real  and  personal,  acquired 
prior  to  March  1,  1913,  the  gain  to  be  returned  is  the  difference  "be- 
tween the  selling  price  and  the  fair  market  price  or  value  as  of  March 
1.  1913,  where  the  selling  price  is  more  than  the  fair  market  price  or 
value  as  of  that  date. 

Cost  of  Real  Estate. 

Cost,  in  the  case  of  real  estate,  may  include  other  items  than  the 
purchase  price.  To  the  purchase  price  may  be  added  the  expense  in- 
cident to  purchase  and  the  cost  of  improvements,  if  any.  In  circum- 
stances where  it  can  be  shown  that  the  corporation  has  not  deducted 
carrying  charges  from  income  of  the  years  in  which  paid,  expendi- 
tures for  interest,  taxes,  insurance,  etc.,  may  also  be  considered  in 
arriving  at  cost.  Among  these  latter  charges  may  be  mentioned  those 
expenses  referred  to  in  the  law  as  "taxes  assessed  against  local  bene- 
fits"— the  assessments  for  local  betterments  that  can  not  be  deducted 
by  either  an  individual  or  a  corporation  in  the  preparation  of  a  return 
of  income.  Such  charges  can,  however,  be  properly  capitalized  in  as- 
certaining the  cost  of  property  in  order  that  gain  resulting  from  a 
sale  or  other  disposition  of  the  property  may  be  determined.  These 
charges  have  been  referred  to  before ;  among  them  are  local  side- 
walk, street  improvement  and  sewer  construction  assessments,  as 
well  as  assessments  for  the  building  of  irrigation  and  drainage  works. 

Fair  Market  Value  of  Real  Estate. 

The  fair  market  price  or  value  of  real  estate  as  of  March  1,  1913, 
would,  obviously,  be  ascertained,  in  a  case  of  ownership  by  a  corpora- 
tion, exactly  as  when  owned  by  an  individual.  It  is,  therefore,  sug- 


114  THE   INCOME   TAX 

gested  -that  the  taxpayer  refer  to  instructions  given  individuals  and 
follow  the  most  suitable  and  most  nearly  accurate  of  the  methods 
therein  outlined. 

Cost  or  Value  of  Securities. 

The  cost  of  such  personal  property  as  stocks  and  bonds,  acquired 
on  or  after  March  1,  1913,  does  not  seem  to  require  definition.  How- 
ever, difficulty  is  sometimes  experienced  in  ascertaining  the  fair 
market  price  or  value  as  of  March  1,  1913,  as  a  basis  for  computing 
gain  from  the  sale  of  securities  acquired  prior  to  that  date.  In  the 
case  of  securities  traded  in  on  the  exchange  on  March  1,  1913,  infor- 
mation as  to  the  fair  market  price  or  value  is  readily  at  hand,  but  in 
the  case  of  securities  not  then  on  the  open  market  the  determining 
data  must  be  sought  elsewhere — from  private  sales,  where  possible, 
or,  if  there  were  no  such  sales,  from  the  value  of  assets  on  March  1 
1913,  considered  in  relation  to  the  value  of  assets  on  the  date  of  dis- 
position of  the  securities. 

When  Paid  for  in  Stock. 

\\  hen  property  has  been  acquired  by  a  corporation  in  exchange 
for  its  capital  stock,  with  the  nominal  par  value  of  the  stock  greatly 
in  excess  of  the  actual  value  of  the  property  acquired,  the  amount  of 
gain  represented  by  a  subsequent  disposition  of  the  property  must  be 
ascertained  by  disregarding  the  par  value  of  the  stock  issued  in  pay- 
ment for  it  and  by  determining  the  actual  value  of  the  property  at  the 
time  of  acquisition,  the  difference  between  the  selling  price  and  such 
actual  value  at  the  time  of  acquisition  to  be  returned  by  the  corpora- 
tion for  the  purpose  of  the  tax. 

215.— IN  MORE  THAN  ONE  BUSINESS. 

A  corporation  engaged  in  more  than  one  kind  of  business  must 
ascertain  its  gross  income  from  all  sources  and  include  the  total  in  its 
return.  Only  interest  on  the  bonds  of  the  United  States  or  its  pos- 
sessions, and  of  a  State  or  political  subdivision  of  a  State,  or  on 
Federal  Farm  Loan  bonds  is  exempt  and  can  be  excluded  in  making 
the  return  for  tax. 

216.—CORPORATION  OPERATING  LEASED  PROPERTY. 

If  a  corporation  has  leased  its  properties  to  another  cor- 
poration in  consideration  of  a  rental  which  is  the  equivalent 
of  a  certain  rate  of  dividends  on  the  outstanding  capital  stock 
and  the  interest  on  the  bonded  indebtedness  of  the  lessor  corporation. 


THE    INCOME   TAX  115 

and  if  such  rental  is  paid  directly  by  the  lessee  corporation  to  the 
stock  and  bond  holders  of  the  lessor  corporation,  a  problem  is  created 
which  should  be  solved  as  follows :  The  lessor  corporation  should  re- 
turn the  amount  of  the  rental  for  tax  and  the  stock  and  bond  holders 
should  account  for  the  amounts  received  by  them  as  dividends  from 
the  lessor  corporation.  The  position  of  the  Department  in  this  re- 
spect is  explained  in  Treasury  Decision  2090  as  follows : 

Payments  measured  by  a  fixed  percentage  on  the  stock  of  a  rail- 
road corporation  whose  lines  are  leased  by  another  railroad  corpora- 
tion and  which  rent  is  payable  by  the  lessee  directly  to  the  stockhold- 
ers of  the  lessor  corporation,  have  under  the  income  tax  law  with  re- 
spect to  the  corporation  paying  such  sums,  the  status  of  a  rental  pay- 
ment. 

In  such  cases  there  are  two  corporations  involved,  the  lessor  and 
the  lessee — one  the  rent  payer  and  the  other  the  rent  receiver.  To  the 
lessee  rental  payments  are  an  expense  of  operation;  to  the  lessor  the 
rentals  are  an  income. 

A  contract  which  provides  that  the  rentals  shall  be  paid  to  a  third 
party,  not  a  party  to  the  contract,  does  not  change  the  character  of  the 
payment,  nor  relieve  the  lessor  from  liability  to  tax  on  the  rental  which 
the  lessee  pays  to  it  or  to  such  third  party.  The  income  of  the  third 
party,  the  stockholder,  is  dividends  on  the  stock  which  he  holds  in  the 
lessor  company.  Dividends  cannot  be  paid  unless  the  lessor  has  an  in- 
come out  of  which  to  pay  them.  Hence  the  lessor  company  is  required 
under  the  law  to  return  as  income  the  rentals  which  the  lessee  is  re- 
quired to  pay.  In  paying  direct  to  the  stockholders  the  lessee  is  acting 
as  agent  of  the  lessor,  and  the  amounts  received  by  the  stockholders 
are,  in  effect  and  in  fact,  dividends  received  out  of  the  earnings  of  the 
lessor. 


H6  THE  INCOME  TAX 


CHAPTER  XVI 


THE  INCOME  TAX 


DEDUCTIONS  ALLOWED  CORPORATIONS 


A.— EXPENSES 
217.— OPERATING  COSTS. 

In  its  return  of  income  a  corporation  is  allowed  to  deduct  from 
gross  income  "all  the  ordinary  and  necessary  expenses  paid  within 
fhe  year  in  the  maintenance  and  operation  of  its  business- and  proper- 
ties." So  reads  the  law,  and  in  great  detail  various  items  of  expense 
have  been  considered  and  passed  upon  in  the  administration  of  the 
statute.  Some  expenditures  are  deducted  under  other  headings  than 
that  of  "Expenses,"  as  will  be  explained,  but,  if  legitimately  charge- 
able against  gross  income,  they  serve  to  reduce  the  amount  of  net  in- 
come subject  to  tax. 

218.— BETTERMENTS  AND  ADDITIONS. 

Expenditures  for  betterments  and  additions  which  represent  a 
permanent  improvement  of  the  property  are  not  allowable  deduc- 
tions. They  are  regarded  as  constituting  an  increase  of  capital  in- 
vestment and  not  as  an  expense  chargeable  against  gross  income  for 
any  year  in  the  computation  of  income  tax  liability. 

219.— RENTAL  EXPENSE. 

The  law  specifically  provides  that  the  deduction  on  account  of  ex- 
pense shall  include  "rentals  or  other  payments  required  to  be  made 
as  a  condition  to  the  continued  use  or  possession  of  property  to  which 
the  corporation  has  not  taken  or  is  not  taking  title,  or  in  which  it  has 
no  equity."  This  payment  may  be  in  cash  or  the  equivalent  of  cash. 
(See  paragraph  on  "Buildings  on  Leased  Ground,"  also  paragraph  on 
"Corporation  Operating  Leased  Property.") 


THE    INCOME   TAX  117 

220.— COST  OF  LABOR  AND  PERSONAL  SERVICES. 

The  entire  cost  of  labor  and  personal  services  is  an  expense  of 
operation  and  maintenance.  In  connection  with  such  payments  there 
have  arisen,  however,  a  number  of  questions  to  which  the  special 
references  below  should  be  made. 

221.— SALARIES  OF  EMPLOYEES. 

Salaries  actually  paid  to  the  officers  and  employees  of  a  corpora- 
tion, if  they  represent  what  the  Treasury  Department  refers  to  as 
"fair  and  reasonable  compensation,"  are  a  deductible  expense.  Just 
what  the  Department  means  by  "fair  and  reasonable  compensation" 
is  not  exactly  known,  but,  presumably,  the  limitation  is  imposed  to 
prevent  the  charging  of  fictitious  salaries  for  excessive  amounts 
against  the  gross  income  of  a  corporation  for  the  purpose  of  reducing 
the  corporation's  income  tax  liability.  Salaries,  to  be  a  proper  item 
of  expense  of  operation  should  not,  under  the  present  ruling,  depend 
upon  the  profits  earned  by  the  corporation. 

222.— COMMISSIONS— IN  CASH  OR  STOCK. 

All  commissions  paid  salesmen  are  legitimately  deductible,  as  an 
expense  of  doing  business.  Even  when  paid  in  stock,  a  commission 
may  be  deducted,  if  so  charged  on  the  books  of  the  corporation,  at  the 
actual  value  of  th^  stock  given  the  salesman. 

223.— SALARIES  TO  ABSENT  SOLDIERS. 

If  a  corporation  continues  to  pay  an  employee  his  salary,  in  whole 
or  in  part,  during  his  service  in  the  army  or  navy  of  the  United  States, 
the  amount  of  such  payment  is  held  by  the  Department  to  be  a  de- 
ductible expense  of  doing  business.  This  ruling  is  applicable  to 
guardsmen  called  into  the  army  and  to  volunteers  or  conscripts  who 
have  joined  the  colors  on  either  land  or  sea. 

224.— WHEN  BASED  ON  STOCK  INTEREST. 

When  an  amount  paid  as  compensation  to  an  officer  or  employee 
of  a  corporation  is  based  upon  the  stockholding  of  such  officer  or  em- 
ployee, it  becomes  a  dividend  and  cannot  be  deducted  as  an  expense  of 
the  business.  It  must  be  treated  as  a  dividend  although  paid  in  lieu 
of  a  salary.  The  United  States  Circuit  Court  of  Appeals  for  the 
Second  Circuit  has  so  decided  in  the  case  of  Jacobs  and  Davies  (Inc.) 
vs.  Anderson  (228  Fed.  505.) 


118  THE   INCOME   TAX 

225.— BONUSES  OR  GIFTS  TO  EMPLOYEES. 

While  a  gift  or  gratuity — when  in  reality  it  is  a  gift  or  gratuity- 
is  not  properly  deductible  in  ascertaining  the  net  income  of  a  corpor- 
ation, there  are  certain  special  payments  in  the  form  of  bonuses,  or  as 
extra  compensation,  made  to  employees  which  are  of  such  character 
that  they  constitute  expenses  allowable  as  deductions.  In  connection 
with  the  payment  of  a  bonus,  however,  the  Department  insists  that 
the  special  compensation  be  for  services  rendered  and  that  the  pay- 
ment be  in  pursuance  of  a  contract,  express  or  implied.  In  a  circular 
letter  the  Department  has  instructed  Internal  Revenue  officers  as  fol- 
lows : 

You  are  informed  that  in  all  cases  where  special  payments,  often 
designated  as  bonuses,  are  made  to  officers  or  employees  of  a  corpora- 
tion pursuant  to  a  contract,  express  or  implied,  as  additional  compensa- 
tion for  services  rendered,  which  payments,  when  added  to  the  stipu- 
lated salaries,  do  not  exceed  a  reasonable  compensation  for  the  services 
rendered,  such  payments  may  be  regarded  as  a  part  of  the  wage  or  hire 
of  the  officer  or  employee,  and,  as  such  may  allowably  be  deducted 
from  gross  income  as  a  business  expense. 

A  long-time  practice,  regularly  employed,  of  paying  to  employees 
certain  sums  in  addition  to  the  stipulated  salaries,  constitutes  a  condi- 
tion, if  not  a  contract,  under  which  the  employees  may  reasonably  ex- 
pect, for  the  greater  or  better  service  which  they  render,  additional 
pay,  and  if,  in  fact,  such  payments  are  made  as  additional  compensa- 
tion for  services  actually  rendered,  and  if  such  payments,  when  added 
to  the  stipulated  salaries,  do  not  exceed  a  reasonable  compensation, 
such  payments,  or  bonuses,  may  be  treated  as  an  "ordinary  and  neces- 
sary expense  of  operation,"  and,  as  such,  deducted  from  gross  income. 
This  ruling  contemplates  that  such  payments  are  conditioned  upon 
the  services  rendered  by  the  employees  and  not  upon  the  earnings  of 
the  corporation.  If  it  should  appear  that  the  additional  or  special  pay- 
ments are  dependent  upon  the  earnings  of  the  company,  rather  than 
upon  the  services  rendered,  or  if  such  payments  are  made  only  occa- 
sionally, and  then,  at  the  option  of  the  corporation  as  a  sort  of  thank- 
offering  because  of  a  prosperous  year,  and  not  in  pursuance  of  a  fixed 
policy  or  practice,  or  any  contract,  express  or  implied,  it  will  be  held 
that  such  payments  are  gratuities  and,  as  such,  are  not  properly  de- 
ductible from  gross  income. 

This  ruling  is  not  intended  to  authorize  in  any  case  the  deduction 
from  gross  income  of  amounts  paid  to  employees  or  others  as  "Christ- 
mas gifts"  even  though  it  has  been  the  practice  of  the  corporation  to 
make  such  gifts.  These  are  held  to  be  voluntary  contributions  or  dona- 
tions and,  as  such,  are  not  deductible. 

In  determining  whether  or  not  the  special  payments  above  re- 
ferred to  are  deductible,  internal  revenue  officers  will  be  guided  by  the 
facts  as  to  whether  or  not  such  payments  are  made  pursuant  to  a  con- 
tract, express  or  implied,  or  to  a  fixed  policy  or  practice,  and  whether 
or  not  they  represent  compensation  for  additional  or  more  efficient 
service  rendered,  and  whether  or  not  such  special  payments,  when  add- 
ed to  the  stipulated  salary  or  wage,  exceed  a  reasonable  compensation. 
Amounts  paid  to  an  officer  or  employee,  who  is  a  stockholder,  in 
excess  of  a  reasonable  compensation  for  his  services,  will  be  treated  as 
in  the  nature  of  dividends,  a  return  upon  his  investment,  and  such 
amounts  will  not  be  deductible. 

226.— PENSIONS  TO  FORMER  EMPLOYEES. 

A  pension  to  a  former  employee,  or  to  his  dependents,  on  account 


THE    INCOME   TAX  119 

of  retirement  after  long  service  or  as  a  result  of  injuries  received  is 
an  allowable  deduction  as  a  business  expense. 

227.— DONATIONS. 

A  donation  by  a  corporation  will  be  closely  scrutinized  and  sub- 
mitted to  the  test  as  to  whether  there  is  a  consideration  for  a  benefit 
to  the  corporation.  If  there  is  no  consideration,  the  amount  given  is 
regarded  as  a  gratuity  and,  as  such,  cannot  be  deducted  in  a  return  of 
income.  An  example  of  a  gratuity,  which  is  not  deductible,  is  the 
payment  of  the  salary  of  an  employee  for  a  time  after  his  death  to  his 
widow  in  recognition  of  his  services,  no  service  being  rendered  by  the 
widow.  An  example  of  a  donation,  which  can  be  deducted  as  a  part 
of  business  expense,  is  a  payment  to  a  hospital  upon  the  consideration 
that  the  employees  of  the  corporation  are  to  have  a  ward  for  their 
own  use  or  other  special  care  in  the  hospital.  But,  in  general,  the 
donations  of  a  corporation  are  of  such  character  as  not  to  be  deducti- 
ble. 

228.— FUEL,   LIGHT  AND   POWER. 

The  amounts  paid  out  by  a  corporation  during  the  year  for  fuel, 
light  and  power  are  deductible  operating  expenses.  These  are  to  be 
treated  the  same  as  other  items  which  so  obviously  constitute  expen- 
diture necessary  in  the  conduct  of  the  corporation's  business. 

229.— REPAIRS  AND  RENEWALS. 

The  cost  of  incidental  repairs,  which  neither  add  to  the  value  of 
the  property  repaired  nor  prolong  its  life  to  any  extent,  may  be  de- 
ducted as  an  expense  of  operation.  Such  repairs  must  not  be  so  ex- 
tensive as  to  constitute  an  addition  or  betterment ;  they  must  not  go 
beyond  the  point  of  keeping  the  property  in  an  operating  condition. 

An  example  of  the  precise  and  discriminating  application  of  the 
limitation  upon  the  cost  of  repairs  as  an  allowable  deduction  for  ex- 
pense is  to  be  found  in  the  case  of  Grand  Rapids  &  Indiana  Railway 
Company  v.  Doyle,  Collector,  decided  in  the  United  States  District 
Court  for  the  Western  District  of  Michigan,  Southern  Division.  The 
court  drew  the  distinction  between  cost  of  repairs  and  cost  of  better- 
ments by  holding  that  where  old  rails  are  replaced  with  new  and 
heavier  rails,  wooden  bridges  and  culverts  with  concrete  and  steel 
bridges  and  culverts,  the  rule  is  that  the  cost  of  renewals  with  like 
kind  and  quality  is  allowable,  but  the  excess  cost  is  not  allowable  as 
a  deduction. 

In  considering  the  allowance  for  repairs  the  taxpayer  should  also 


120  THE   INCOME   TAX 

give  close  attention  to  the  allowance  for  depreciation,  for  the  law  con- 
templates a  deduction  on  account  of  the  exhaustion,  wear  and  tear,  of 
property  from  its  use  or  employment  in  business,  in  addition  to  the 
expenditure  necessary  to  keep  the  property  in  an  operating  condition. 
[See  instructions  regarding  "Depreciation."] 

230.— EXPENSES  OF  ENTERTAINMENT. 

Money  advanced  to  salesmen  for  entertainment  when  the  spend- 
ing of  it  is  a  part  of  the  selling  expense  of  the  corporation's 
product  can  be  deducted  by  the  corporation  as  a  business  expense. 

231.— BUILDINGS  ON  LEASED  GROUND. 

When  a  building  is  erected  on  leased  ground  under  an  agreement 
that  it  is  to  be  left  on  the  ground  at  the  expiration  of  the  lease,  the 
cost  is  held  to  be  a  proper  deduction  as  a  rental  charge.  This  cost 
should  be  prorated  over  the  number  of  years  constituting  the  term  of 
the  lease  and  the  prorata  belonging  to  one  year  treated  as  a  business 
expense  in  the  corporation's  return  for  each  year  thereafter  until  the 
expiration  of  the  lease. 

232.— IMPROVEMENTS  ON  LEASED  PROPERTY. 

And  the  same  rule  applies  to  expenditures  for  repairs  or  improve- 
ments on  leased  premises  if  the  tenant  occupies  the  premises  under 
a  lease  contract  which  requires  that  such  repairs  and  improvements 
be  made  at  the  expense  of  the  tenant  and  revert  to  the  owner  of  the 
fee  at  the  expiration  of  the  lease.  The  cost  can  be  deducted  by  the 
tenant  as  a  part  of  the  general  expense  of  doing  business.  In  case  of 
an  expenditure  for  an  improvement  of  somewhat  permanent  char- 
acter, the  cost  of  the  improvement  should  be  prorated  over  the  term 
of  the  lease. 

233.— POLITICAL  AND  LOBBYING  EXPENSES. 

Contributions  to  political  campaigns  and  expenditures  in  lobby- 
ing cannot  be  deducted  in  a  corporation's  return  of  income.  While 
such  expenditures  may  be  regarded  as  a  very  considerable  item  of  ex- 
pense, the  Treasury  Department  holds  that  they  are  not  the  "ordinary 
and  necessary  expenses"  authorized  as  deductions  by  the  law. 

234.— EXPENSE  ACCOUNTS  PAYABLE. 

Accounts  payable,  when  they  represent  the  ordinary  and  neces- 
sary business  expenses  allowed  by  the  law  as  deductions,  may  be  de- 
ducted from  gross  income  of  the  year  in  which  the  expenses  are  in- 
curred, provided  the  accounts  have  been  so  entered  upon  the  books  of 


THE    INCOME   TAX  121 

the  corporation  as  to  constitute  a  liability  against  the  assets  of  the 
corporation  and  as  not  to  be  included  in  the  deductions  for  the  year 
in  which  actually  paid  in  cash.  This  privilege  is  even  extended  the 
corporation  which  does  not  avail  itself  of  the  general  right  given  by 
the  law  to  make  return  according  to  its  own  method  of  accounting, 
subject  to  approval  by  the  Treasury  Department,  provided  it  prefer 
its  own  method  to  a  strict  basis  of  actual  receipts  and  disbursements. 

235.— INTEREST  AS   EXPENSE   RATHER 
THAN  INTEREST  DEDUCTION. 

Interest  paid  by  a  corporation  on  indebtedness  which  is  wholly 
secured  by  property  collateral  the  subject  of  sale  or  hypothecation  in 
the  ordinary  business  of  the  corporation,  as  a  dealer  only  in  the  prop- 
erty constituting  such  collateral  must  be  deducted  as  a  business  ex- 
pense. It  is  not  to  be  included  in  the  general  deduction  on  account  of 
interest  paid.  There  is  reason  for  this.  Subject  only  to  the  limitation 
that  the  amount  of  the  indebtedness  on  which  such  interest  paid  is 
allowable  as  a  deduction  shall  not  exceed  the  actual  value  of  the  prop- 
erty collate,  al,  the  entire  amount  of  interest  paid  during  the  year  on 
indebtedness  thus  secured  can  be  deducted.  On  the  other  hand  there 
is  a  strict  limitation  upon  the  separate  deduction  for  interest.  (For 
further  explanation  see  treatment  of  deductions  for  interest.) 

236.— EXPENSES  IN  CONTRACTING  BUSINESS. 

If  a  corporation  is  engaged  in  the  contracting  business  and  makes 
its  return  of  income  upon  the  basis  of  completed  jobs,  it  must  confine 
its  deductions  for  operating  expense  to  expenditures  made  on  account 
of  such  completed  contracts. 

237.— INCOME  FROM   PUBLIC  UTILITY 
DUE  STATE,  CITY,  ETC. 

If  a  public  utility  has  been  constructed  and  is  operated  under  a 
contract  with  a  State  or  Municipality  providing  that  a  portion  of  the 
net  earnings  shall  be  paid  to  the  State  or  Municipality,  the  amount  so 
paid  is  regarded  as  a  business  expense  to  the  corporation  (or  indi- 
vidual) operating  the  public  utility  and,  as  such,  may  be  deducted  in 
a  return  of  income. 

238.— MISCELLANEOUS  EXPENSES. 

There  are  many  other  items  of  expense  properly  to  be  considered 
in  ascertaining  the  net  income  of  a  corporation  subject  to  tax.  All  of 
them  cannot  be  named  here.  But  the  language  of  the  law  is  compre- 
hensive. "All  the  ordinary  and  necessary  expenses  paid  within  the 


122  THE    INCOME   TAX 

year  in  the  maintenance  and  operation  of  its  business  and  properties," 
it  reads ;  and  the  Treasury  Department  has  interpreted  the  provision 
of  the  statute  to  mean  that  "expenses  of  operation  and  maintenance 
shall  include  all  expenditures  for  material,  labor,  fuel  and  other  items 
entering  into  the  cost  of  the  goods  sold  or  inventoried  at  the  end  of 
the  year,  and  all  other  expenses  incurred  in  the  operation  of  the  busi- 
ness except  such  as  are  required  by  the  Act  to  be  segregated  in  the 
return."  (Referring  to  interest,  taxes,  losses,  depreciation  and  deple- 
tion.) 

B.— LOSSES 

239.— MUST  BE  ABSOLUTE  AND  COMPLETE. 

The  deduction  allowed  for  losses  must  be  considered  separately 
from  that  allowed  for  depreciation  of  physical  property  due  to  wear 
and  tear,  or  that  allowed  for  depletion  of  natural  deposits  in  the  earth. 
Under  the  item  of  "Losses"  deduction  can  be  claimed  only  for  such  a 
loss  as  has  been  actually  sustained  during  the  year,  without  compen- 
sation in  the  form  of  insurance  or  otherwise.  The  loss  must  also 
have  been  charged  off  on  the  books  during  the  year.  In  every  sense 
it  must  be  complete  and  absolute,  without  apparent  possibility  of  re- 
covery. Unless  the  loss  can  meet  this  severe  test  it  will  not  be  al- 
lowed, for  of  all  the  items  of  deduction  in  a  return  of  income  that 
which  receives  the  most  critical  scrutiny  is  the  item  of  losses.  Hence, 
the  corporation  must  have  data  to  support  its  claims  on  account  of 
losses.  It  will  only  waste  time  and  effort  by  writing  estimated  losses 
into  the  return  it  is  required  to  file  with  the  Government. 

240.— LOSS  FROM  SALE  OF  PROPERTY. 

A  loss  from  the  sale  or  other  disposition  of  property,  real  or  per- 
sonal, is  ascertained  precisely  as  explained  with  reference  to  deter- 
mination of  gain  in  a  similar  transaction.  In  the  case  of  property  ac- 
quired prior  to  March  1,  1913,  the  loss  is  the  difference  between  the 
fair  market  price  or  value  of  the  property  as  of  that  date  and  the  sell- 
ing price,  where  the  selling  price  is  less  than  the  market  price  or 
value  as  of  March  1,  1913.  In  the  case  of  property  acquired  on  or 
after  March  1,  1913,  the  loss  is  the  difference  between  selling  price 
and  cost,  where  the  selling  price  is  less  than  the  cost. 

This  provision  of  the  law  can  be  applied  to  transactions  in  stocks 
and  bonds  as  well  as  to  dealings  in  real  estate. 

Items  of  Cost. 

With  respect  to  property  acquired  on  or  after  March  1,  1913,  (in 
which  case  cost  is  the  basis  for  calculating  gain  or  loss)  certain  items 


THE    INCOME   TAX  123 

in  addition  to  purchase  price  may  be  considered  in  ascertaining  cost. 
To  the  purchase  price  may  be  added  expense  incident  to  purchase,  the 
cost  of  improvements,  special  assessments  paid  for  local  benefits  and, 
in  certain  cases,  the  carrying  charges  against  the  property.  With 
reference  to  the  inclusion  of  carrying  charges,  the  Department  holds 
that,  where  they  exceed  income  from  the  property,  the  amount  of  the 
excess  can  be  considered  in  ascertaining  cost  of  the  property.  This 
ruling  does  not  mean  that  carrying  charges,  if  they  consist  of  such 
expenditures  as  constitute  allowable  deductions  from  gross  income, 
are  to  be  added  to  the  cost  of  the  property,  if  there  is  a  gross  income 
from  which  they  can  be  deducted;  but  it  does  mean  that  in  the  case 
of  a  corporation  which  has  not  yet  progressed  to  the  point  of  having 
any  income  of  consequence  from  its  corporate  operations,  the  excess 
of  the  carrying  charges  over  the  incidental  income  received  may  be 
made  a  part  of  the  cost  of  the  property. 

241.— BAD  DEBTS. 

Any  amount  represented  by  a  bad  debt,  charged  off  the  corpora- 
tion's books  during  the  year,  can  be  deducted.  It  is  essential,  how- 
ever, that  the  amount  have  been  charged  off.  If  subsequently  the 
amount  is  recovered  it  must  be  accounted  for  as  income  for  the  year 
in  which  recovered. 

Under  this  heading  would  be  proper  as  a  deduction  any  amount 
lost  on  account  of  a  sale  of  real  estate  in  the  case  of  a  sale  with  the 
consideration  represented  in  whole  or  in  part  by  deferred  payments 
covered  by  notes  and  a  mortgage. 

Also  under  this  heading  should  be  deducted  loss  sustained  on  ac- 
count of  the  insolvency  of  a  corporation  with  an  outstanding  bond  is- 
sue. The  bonds  are  a  debt  of  the  corporation  which  has  issued  them 
and  the  bondholder  is  the  creditor.  If  insolvency  of  the  corporation 
has  made  the  bonds  worthless,  the  holder  of  them  is  entitled  to  de- 
duct the  amount  of  loss  as  a  bad  debt. 

242.— LOSSES  FROM  CASUALTY. 

Losses  from  casualty,  such  as  fire,  storm,  shipwreck  or  theft,  are 
deductible  by  a  corporation,  if  not  compensated  for  by  insurance  or 
otherwise.  If  the  amount  of  loss  sustained  by  casualty  can  be  shown 
to  be  in  excess  of  the  amount  of  insurance,  the  amount  of  such  excess 
is  deductible. 

243.— COST,  SALVAGE,  PREVIOUS  DEPRECIATION. 

Cost  value  and  salvage  value  must  be  considered  in  determining 


124  THE    INCOME   TAX 

the  amount  of  loss  with  respect  to  any  property.  Also  a  factor  in 
such  computation  is  the  amount  which  has  at  any  time  been  deducted 
from  gross  income  for  depreciation  of  the  property  in  question  and 
which  has  not  been  expended  in  making"  good  the  depreciation. 

244.— REMOVAL  OF  BUILDINGS. 

If  a  building  is  voluntarily  removed  to  make  room  for  a  new 
building  there  is  no  loss  sustained  which  is  deductible  as  a  loss,  ac- 
cording to  the  ruling  of  the  Department.  Such  loss  is  either  a  proper 
charge  to  the  cost  of  the  new  building  or  is  presumed  to  have  been 
taken  care  of  in  previous  deductions  for  depreciation.  So  much  of 
such  loss  as  has  not  been  covered  by  depreciation  charges  should  be 
added  to  and  made  a  part  of  the  cost  of  the  new  building,  for  the  pur- 
poses of  the  income  tax  law.  In  any  case  it  does  not  enter  into  the 
computation  of  net  income  for  the  year  in  which  the  old  building  is 
removed. 

245.— SELLING  BONDS  AT  DISCOUNT. 

Where  a  corporation  issues  bonds,  redeemable  at  par,  and  dis- 
poses of  such  bonds  at  a  price  less  than  par,  there  is  plainly  a  proper 
charge  to  be  made  against  the  gross  income  of  the  corporation.  The 
difference  between  sale  price  and  par  is  a  loss.  Both  the  Treasury 
Department  and  the  courts,  have  held,  however,  that  the  amount  of 
this  loss  must  be  prorated  by  the  corporation  over  the  life  of  the 
bonds,  the  proportion  of  the  amount  of  the  discount  belonging  to  one 
year  to  be  charged  against  gross  income  for  each  year. 

For  example :  A  twenty-year  bond  for  $100,  redeemable  at  par, 
would,  if  disposed  of  at  $80,  mean  a  loss  of  $20,  to  be  prorated  over 
the  twenty  years  constituting  the  life  of  the  bond.  On  account  of 
such  bond  the  corporation  would  be  entitled  to  claim  a  deduction  for 
loss  to  the  amount  of  one  dollar  in  its  return  for  each  year  during  the 
•ife  of  the  bond. 

A  corporation  is  not  allowed  to  charge  the  entire  amount  of  a 
discount  in  the  sale  of  its  bonds  against  gross  income  for  the  year  in 
which  the  bonds  are  disposed  of.  In  the  case  of  the  Baldwin  Locomo- 
tive Works  vs.  McCoach,  Collector  [221  Fed.  59],  the  United  States 
Circuit  Court  of  Appeals  for  the  Third  Circuit  held  to  the  effect  that, 
while  the  amount  of  the  discount  in  such  a  case  is  properly  chargeable 
against  gross  income,  it  will  not  be  paid  until  the  maturity  of  the 
bonds  and  therefore  should  be  prorated  over  the  life  of  the  bonds. 

However,  writh  respect  to  this  question  of  bond  discount,  it  is  well 
to  note  that  in  a  case  where  a  corporation  disposed  of  its  bonds  at  a 


THE    INCOME   TAX  125 

discount  prior  to  the  year  1909  and  at  the  time  charged  the  entire 
amount  of  the  discount  against  income  for  the  year  in  which  the 
bonds  were  sold,  such  corporation  cannot,  in  a  return  for  any  subse- 
quent year,  claim  any  part  of  the  amount  of  the  discount  as  a  loss. 
Reference  is  made  to  the  year  1909  because  the  Corporation  Excise 
Tax  (forerunner  of  the  Corporation  Income  Tax)  became  effective 
January  1,  1909. 

246.— RETIRING  BONDS  ABOVE  PAR. 

By  official  letter  the  Treasury  Department  has  given  a  clear  and 
concise  ruling  with  respect  to  the  situation  created  when  a  corpora- 
tion is  required,  under  the  terms  of  its  indenture  securing  a  bond  is- 
sue, to  purchase  and  retire  annually  a  certain  number  of  its  bonds, 
and  when  the  corporation  must  pay  more  than  par  for  the  bonds  it  is 
required  to  retire.  In  such  circumstances,  a  loss  is  generally  sus- 
tained. As  to  the  treatment  of  such  a  loss  the  Treasury  Department 
has  ruled  as  follows  : 

If  tfce  bonds  were  issued  at  par,  then  the  corporation  may  deduct 
the  difference  between  par  and  the  price  at  which  purchased  for  retire- 
ment. 

If  the  bonds  were  issued  at  a  premium  and  such  premium  account- 
ed for  as  income  for  the  year  in  which  issued,  then  the  difference  be- 
tween par  and  the  purchase  price  may  be  deducted  as  a  loss;  but,  if  the 
premium  at  which  the  bonds  were  issued  had  not  been  carried  into  in- 
come account,  then  the  loss  to  be  claimed  should  be  the  difference  be- 
tween the  price  at  which  the  bonds  were  issued  and  the  purchase  price. 

In  the  event  that  the  bonds  were  issued  at  a  discount  and  the  dis- 
count was  charged  against  the  earnings  of  the  year  in  which  issued,  the 
difference  between  par  and  the  purchase  price  may  be  deducted  as  a 
loss;  but  if  the  discount  on  the  bonds  was  prorated  over  the  life  of  the 
bonds  and  the  annual  proportion  charged  against  the  yearly  income,  the 
amount  to  be  charged  off  as  a  loss  for  the  year  in  which  the  bonds  are 
purchased  for  retirement  should  be  the  difference  between  the  price  at 
which  the  bonds  were  issued  and  the  purchase  price  minus  an  allow- 
ance for  the  sums  that  had  been  charged  off  annually  on  account  of  the 
prorated  discount  on  such  bonds. 

247.— INFORMATION   MUST   BE   EXACT. 

There  can  be  no  guesswork  or  approximation  in  connection  with 
a  claim  for  deduction  on  account  of  loss.  In  the  form  of  return,  pro- 
vided by  the  Government,  will  be  found  specific  questions,  which  must 
be  answered.  Not  only  must  the  kind  of  asset  involved  in  the  loss  be 
stated,  but  also  how  and  when  the  loss  was  ascertained  to  be  such, 
with  full  data  relative  to  cost,  or  fair  market  price  or  value  as  of 
March  1,  1913,  as  the  case  may  be.  If  fair  market  price  or  value  as  of 
March  1,  1913,  is  the  basis  of  determining  loss,  the  method  of  ascer- 
taining such  fair  market  price  or  value  must  also  be  explained. 


126  THE    INCOME   TAX 

C.—DEPRECIATION 

The  subject  of  depreciation  of  physical  property,  and  the  charge 
that  may  be  made  against  gross  income  on  this  account,  is  one  that 
concerns  both  the  corporation  and  the  individual.  It  has  given  rise  to 
many  vexing  problems,  to  many  differences  of  opinion ;  and,  no  doubt, 
always  will.  However,  the  basic  requirements  of  the  law,  as  interpre- 
ted by  the  Treasury  Department,  can  be  laid  down  and  the  taxpayer, 
corporation  or  individual,  should  adhere  to  them  with  all  possible 
fidelity.  This  advice  is  given  because  deductions  from  gross  income 
on  this  account  are  looked  into  very  carefully  by  the  Government. 

It  has  been  thought  best  to  explain  the  subject  in  a  separate 
chapter ;  hence  the  taxpayer  is  referred  to  the  special  chapter  on  "De- 
preciation of  Physical  Property." 

D.— DEPLETION 

As  in  the  case  of  deduction  for  depreciation,  so  with  respect  to 
deduction  for  depletion,  it  has  been  thought  best  to  cover  the  subject 
in  a  special  chapter  under  the  heading,  "Depletion  of  Natural  De- 
posits." 

It  is  a  difficult  problem  to  solve  in  most  cases — this  determination 
of  the  fair  annual  allowance  for  exhaustion  of  deposits  hidden  away 
in  the  earth.  Ever  since  the  Corporation  Excise  Tax  law  of  August  5, 
1909,  became  effective  controversy  between  the  Government  and  tax- 
payers on  the  subject  has  been  acute,  and,  no  doubt,  will  be  continued. 
However,  the  requirements  of  the  Government  can  be  set  forth  and 
taxpayers  will  do  well  to  follow  them  even  though  they  may  think 
that  the  Treasury  Department  is  as  far  from  an  equitable  solution  of 
the  problem  as  it  was  in  the  first  place.  Hence,  the  taxpayer  is  re 
ferred  to  the  special  chapter  as  above  indicated. 

E.— DEDUCTION   OF   INTEREST 

The  deduction  for  interest  is  one  governed  by  a  specific  and  arbi- 
trary limitation  imposed  by  law  and  by  several  provisional  clauses  to 
which  the  closest  attention  should  be  given.  A  number  of  decisions 
have  been  made  and  interpretations  issued  by  the  Treasury  Depart- 
ment. However,  before  going  into  their  meaning,  it  has  been  thought 
best  to  quote  here  the  provision  of  the  law  allowing  deduction  for  in- 
terest. The  language  of  the  statute  (to  be  found  in  the  "Third"  para- 
graph of  subdivision  (a)  of  Section  12)  follows,  with  special  division 
of  the  subject  into  "Parts"  for  the  sake  of  convenience  and  explana- 
tion: 

PART   1. 
The  amount  of  interest  paid  within  the  year  on  its  indebtedness 


THE    INCOME   TAX  127 

(except  on  indebtedness  incurred  for  the  purchase  of  obligations  or  se- 
curities the  interest  upon  which  is  exempt  from  taxation  as  income 
under  this  title)  to  an  amount  of  such  indebtedness  not  in  excess  of  the 
sum  of 

(a)  the  entire  amount  of  the  paid-up  capital  stock  outstanding  at  the 
close  of  the  year,  or,  if  no  capital  stock,  the  entire  amount  of  capital 
employed  in  the  business  at  the  close  of  the  year,  and 

(b)  one-half  of  its  interest-bearing  indebtedness  then  outstanding: 

PART  2. 

Provided,  That  for  the  purpose  of  this  title  preferred  capital  stock 
shall  not  be  considered  interest-bearing  indebtedness,  and  interest  or 
dividends  paid  upon  this  stock  shall  not  be  deductible  from  gross  in- 
come: 

PART  3. 

Provided  further,  That  in  cases  wherein  shares  of  capital  stock  are 
issued  without  par  or  nominal  value,  the  amount  of  paid-up  capital 
stock,  within  the  meaning  of  this  section,  as  represented  by  such 
shares,  will  be  the  amount  of  cash,  or  its  equivalent,  paid  or  trans- 
ferred to  the  corporation  as  a  consideration  for  such  shares: 

PART  4. 

Provided  further,  That  in  the  case  of  indebtedness  wholly  secured 
by  property  collateral,  tangible  or  intangible,  the  subject  of  sale  or 
hypothecation  in  the  ordinary  business  of  such  corporation,  joint-stock 
company  or  association  as  a  dealer  only  in  the  property  constituting 
such  collateral,  or  in  loaning  the  funds  thereby  procured,  the  total  in- 
terest paid  by  such  corporation,  company,  or  association  within  the 
year  on  any  such  indebtedness  may  be  deducted  as  a  part  of  its  ex- 
penses of  doing  business,  but  interest  on  such  indebtedness  shall  only 
be  deductible  on  an  amount  of  such  indebtedness  not  in  excess  of  the 
actual  value  of  such  property  collateral: 

PART  5. 

Provided  further,  That  in  the  case  of  bonds  or  other  indebtedness, 
which  have  been  issued  with  a  guaranty  that  the  interest  payable 
thereon  shall  be  free  from  taxation,  no  deduction  for  the  tax  herein  im- 
posed, or  any  other  tax  paid  pursuant  to  such  guaranty,  shall  be 
allowed : 

PART  6. 

And  in  the  case  of  a  bank,  banking  association,  loan  or  trust  com- 
pany, interest  paid  within  the  year  on  deposits  or  on  moneys  received 
for  investment  and  secured  by  interest-bearing  certificates  of  indebted- 
ness issued  by  such  bank,  banking  association,  loan  or  trust  company 
shall  be  deducted. 

248.— ON  LOAN  TO  BUY  TAX-FREE  BONDS. 

First  consider  the  exception  with  respect  to  interest  paid  on  in- 
debtedness incurred  for  the  purchase  of  bonds  the  interest  on  which 
is  not  subject  to  tax.  (Part  1  above).  This  was  written  into  the  law 
by  an  amendment  carried  by  the  War  Revenue  Act  of  October  3,  1917, 
and  refers  to  indebtedness  incurred  to  purchase  United  States,  State, 


.128  THE    INCOME   TAX 

Municipal,  School,  and  similar  bonds — the  securities  specially  favored 
by  the  law  and  more  fully  described  elsewhere  under  appropriate 
headings  in  this  book.  It  has  no  reference  to  the  so-called  "tax-free" 
bonds  issued  by  corporations. 

An  example :  A  corporation  borrows  $100,000  and  invests  the 
amount  in  school  district  bonds.  It  cannot  deduct  the  interest  paid  on 
the  indebtedness  of  $100,000.  Suppose  it  has  borrowed  the  money  at 
6  per  cent  and  has  bought  school  bonds  paying  6  per  cent  interest.  It 
would  not  have  to  include  in  its  statement  of  income  the  $6,000  in  in- 
terest earned  by  the  school  bonds  but,  if  it  were  allowed  to  deduct  the 
$6,000  in  interest  paid  on  the  loan  of  $100,000,  such  deduction  would 
be  a  charge  against  income  from  sources  other  than  the  school  bonds 
and  the  amount  of  tax  liability  on  income  from  those  other  sources 
would  be  accordingly  decreased. 

The  purpose  of  the  law  is  plain.  Where  it  is  allowable  to  deduct 
interest  paid  on  such  a  loan,  transactions  of  this  kind  might  be  carried 
to  almost  any  extent  to  evade  taxation. 

249.— INTEREST  MUST  HAVE  BEEN  PAID. 

Interest  to  be  deductible  not  only  must  have  been  computed  ac- 
cording to  law,  but  must  also  have  been  actually  paid  within  the  year 
for  which  the  return  is  made. 

250.— BASIS  OF  COMPUTATION. 

The  statute  places  a  specific  limitation  (Part  1,  above)  upon  the 
amount  of  indebtedness  on  which  deductible  interest  can  be  computed 
—that  is,  interest  other  than  such  interest  as  is  described  in  Parts  4 
and  6,  above. 

This  limitation  is  ascertained  by  adding  to  the  amount  of  the 
paid-up  capital  stock  outstanding  at  the  close  of  the  year  one-half  of 
the  interest-bearing  indebtedness,  also  then  outstanding.  Such  is  the 
maximum  principal  on  which  deductible  interest  can  be  computed.  In 
the  case  of  a  corporation  with  a  paid-up  capital  stock  of  $100,000,  a 
bond  issue  of  $250,000  and  no  other  indebtedness  outstanding  at  the 
close  of  the  year,  the  maximum  principal  would  be  the  sum  of 
$100,000  and  $125,000  (y2  of  $250,000)  or  $225,000.  Thus,  in  such 
circumstances  (and  this  is  often  the  case)  the  corporation  could  not 
deduct  the  entire  amount  of  interest  paid  on  its  bonds,  but  would  be 
limited  to  interest  paid,  on  them  only  to  the  amount  of  $225,000  of  the 
par  value  of  the  bonds. 


THE    INCOME   TAX  129 

251.— PAID-UP   CAPITAL   STOCK. 

By  "Paid-up  Capital  Stock"  is  meant  the  par  value  of  the  stock 
issued  and  outstanding  at  the  close  of  the  year,  without  consideration 
of  any  surplus  the  corporation  may  have.  However,  when  the  stock 
has  been  sold  according  to  an  installment  plan  and  has  not  been  en- 
tirely paid  for,  the  amount  actually  paid  on  it  represents  "paid-up 
capital  stock,"  holds,  the  Department.  But  if  payment  in  any  form 
(by  cash,  promissory  notes  or  by  other  assets)  has  been  made  in  full, 
then  the  par  value  of  the  stock  issued  and  outstanding  at  the  close  of 
the  year  is  to  be  taken  into  the  computation. 

252.— IF  STOCK  HAS  NO  PAR  VALUE. 

When  a  corporation  issues  stock  without  giving  to  each  share  a 
par  or  nominal  value  (Part  3,  above),  the  law  provides  that  the 
amount  to  be  taken  into  the  computation  with  respect  to  deductible 
interest  is  the  amount  paid  to  the  corporation  for  its  stock,  and,  as 
hereinbefore  noted,  payment  may  be  in  cash  or  the  equivalent  of  cash 
in  the  form  of  notes  or  other  assets.  [See  fourth  paragraph  farther 
on  headed  "Common  Stock  As  a  Bonus,  Etc."] 

253.— IF  NO  CAPITAL  STOCK. 

If  no  capital  stock  has  been  issued  (Part  1,  above)  it  is  provided 
that  the  entire  amount  of  capital  employed  in  the  business  at  the  close 
of  the  year  shall  be  considered  the  same  as  "paid-up  capital  stock." 

254.— OUTSTANDING  AT  CLOSE  OF  YEAR. 

The  law  is  again  specific  (Part  1,  above)  in  fixing  a  maximum  of 
principal  according  to  both  paid-up  capital  stock  and  interest-bearing 
indebtedness  outstanding  at  the  close  of  the  year, — that  is,  at  the 
close  of  the  year  for  which  the  corporation  makes  its  return  and 
which  may  be  either  the  calendar  year  or  the  corporation's  own  fiscal 
year. 

Suppose  a  corporation  with  an  outstanding  paid-up  capital  stock 
of  $100,000  (par  value)  has  carried  an  indebtedness  of  $250,000  for  the 
greater  part  of  the  year  but  on  the  first  day  of  October  was  able  to 
and  did  pay  this  indebtedness  in  full,  so  that  on  the  last  day  of  Decem- 
ber it  did  not  have  any  indebtedness  outstanding.  During  the  year  it 
paid  interest  on  its  indebtedness.  How  would  its  deduction  for  in- 
terest be  computed?  The  Treasury  Department  answers  in  Treasury 
Decision  1960  as  follows  : 

If  no  indebtedness  is  outstanding  at  the  close  of  the  year,  the  maxi- 
mum deduction  allowable  on  account  of  interest  paid,  will  be  the 
amount  of  interest  actually  accrued  and  paid  on  an  amount  of  indebted- 


130  THE    INCOME   TAX 

ness  not  exceeding  at  any  time   within   the   year,    the    entire   paid-up 
capital  stock  outstanding  at  the  close  of  the  taxable  year  [in  this  case 
the  last  day  of  December,]    that  is,   in   such   case,  the  paid-up  capital 
stock  outstanding  at  the  close  of  the  year  measures  the  highest  amount 
of  indebtedness  upon  which  deductible  interest  can  be  computed. 
In  the  example  given,  according  to  the  Department's  interpreta- 
tion of  the  law,  the  maximum  principal  on  which  deductible  interest 
could  be  computed  would  be  $100,000. 

Were  the  example  changed  to  provide  merely  for  a  reduction  of 
the  indebtedness  of  $250,000  late  in  the  year,  leaving  $150,000  of  it 
outstanding  at  the  close  of  the  year,  the  maximum  principal  would  be 
$100,000  plus  $75,000  (ft  of  $150,000)  or  $175,000. 

255.— DIFFERENT  RATES  OF  INTEREST. 

Bearing  upon  this  question  attention  is  directed  to  one  of  the  few 
rulings  issued  on  January  5,  1914,  in  Regulations  No.  33  and  still  in 
effect.  It  follows : 

Interest  on  bonded  or  other  indebtedness  bearing  different  rates 
of  interest  may  be  deducted  from  gross  income  during  the  year,  provid- 
ed the  aggregate  amount  of  such  indebtedness  on  which  the  interest  is 
paid  does  not  exceed  the  limit  prescribed  by  law,  and  in  case  the  in- 
debtedness is,  in  excess  of  the  amount  on  which  interest  may  be  legally 
deducted,  the  indebtedness  bearing  the  highest  rate  may  be  first  con- 
sidered in  computing  the  interest  deduction  and  the  balance,  if  any, 
will  be  computed  upon  the  indebtedness  bearing  the  next  lower  rate 
actually  paid,  and  so  on  until  interest  on  the  maximum  principal 
allowed  has  been  computed. 

256.— COMMON  STOCK  AS  BONUS,  ETC. 

As  special  problems  have  arisen  they  have  necessitated  amplifi- 
cation of  the  Department's  interpretation  of  the  law.  Particularly 
has  this  been  true  with  respect  to  issues  of  stock  without  par  value 
and  issues  of  common  stock  as  a  bonus  in  connection  with  preferred 
stock.  In  an  official  letter  the  Department  has  stated  its  understand- 
ing of  the  requirements  of  the  law  as  follows : 

"Paid-up  capital  stock,"  is  held  to  mean  that  amount  of  capital  paid 
in  and  for  which  certificates  or  shares  are  issued.  For  the  purpose  of 
the  act,  it  is  not  essential  that  the  shares,  when  issued,  shall  have  set 
out  therein  a  nominal  or  par  value.  Hence,  for  the  purpose  of  the  act, 
it  is  held  that  shares  of  stock  issued,  whether  with  or  without  a  par  or 
nominal  value,  are  "paid-up  capital  stock"  within  the  meaning  of  the 
law;  and  the  amount  of  "paid-up  capital  stock"  to  be  set  forth  in  the 
return,  as  one  of  the  determining  elements  in  computing  the  amount  of 
interest  which  may  be  allowably  deducted,  is  the  amount  of  capital 
(cash  or  its  equivalent)  actually  received  by  the  corporation  and  for 
which  shares  are  issued. 

In  the  case  of  shares  of  stock  issued  with  a  par  value  fully  paid  up 
and  non-assessable,  the  par  value  of  all  such  shares  so  issued  is  the 
paid-up  capital  stock  of  the  corporation. 

In  the  case  of  shares  of  stock  issued  without  par  value,  the  amount 
of  capital  actually  received  and  for  which  such  shares  are  issued  is  the 
paid-up  capital  stock. 


THE    INCOME   TAX  131 

As  in  the  case  of  capital  stock  issued  with  par  value,  so  in  the  case 
of  stock  issued  without  par  value,  the  amount  of  the  "paid-up  capital 
stock,"  for  the  purposes  of  this  act,  cannot  be  increased  except  as  new 
capital  is  paid  in  and  for  which  additional  shares  are  issued. 

In  cases  wherein  shares  of  stock  are  issued  without  par  value,  such 
stock  is  obviously  common  stock.  If  it  should  occur  that  such  shares 
are  issued  in  addition  to  or  as  a  bonus  in  connection  with  shares  of  pre- 
ferred stock,  which  latter  must  necessarily  have  a  par  or  nominal  value, 
and  the  entire  capital  paid  in  is  represented  by  the  par  value  of  the  pre- 
ferred stock,  then  and  in  that  case  the  "paid-up  capital  stock,"  for  all 
the  purposes  of  the  income  tax  law,  will  be  the  par  value  of  the  pre- 
ferred stock. 

If  both  common  and  preferred  stock  are  issued  for  a  cash  or  other 
equivalent  consideration,  the  "paid-up  capital  stock,"  within  the  mean- 
ing of  the  law,  will  be  the  par  value  (if  fully  paid  in)  of  the  preferred 
stock  plus  the  amount  actually  paid  in  on  the  shares  issued  without  par 
or  nominal  value. 

It  is  therefore  held  that  a  corporation  whose  shares  of  stock  are 
issued  without  par  value  has  a  "paid-up  capital  stock"  within  the  mean- 
ing of  the  law,  equal  to  the  amount  paid  in  for  such  stock,  and  it  will 
be  authorized  to  compute  its  interest  deduction  in  accordance  with  the 
rule  set  out  in  the  law  for  corporations  having  a  paid-up  capital  stock 
the  paid-up  capital  stock  in  such  cases  being  the  actual  paid-in  capital 
for  which  shares  are  issued. 

257.— INTEREST  ON  PREFERRED  STOCK. 

With  respect  to  the  interest,  so-called,  or  dividends,  paid  on  pre- 
ferred capital  stock  (Part  2,  above)  issued  by  a  corporation,  the  law 
provides  there  shall  be  no  deduction. 

258.— INTEREST  ON  INDEBTEDNESS  SECURED 
BY  COLLATERAL  WHICH  IS  SUBJECT  OF 
SALE  IN  CORPORATION'S  BUSINESS. 

Referring  to  Part  4  of  the  quotation  from  the  Income  Tax  law  in 
regard  to  deductions  of  interest,  a  corporation  should  give  the  closest 
attention  to  the  very  important  exception  with  respect  to  interest 
paid  on  indebtedness  wholly  secured  by  property  collateral,  tangible 
or  intangible,  which  property  is  the  subject  of  sale  or  hypothecation 
in  the  ordinary  business  of  the  corporation  as  a  dealer  only  in  the 
property  constituting  the  collateral,  or  in  loaning  the  funds  procured. 

The  importance  of  this  exception  is  due  to  the  provision  that  in- 
terest paid  on  such  indebtedness  is  deductible  as  one  of  the  expenses 
of  doing  business  and  is  not  to  be  considered  as  a  part  of  the  general 
deduction  for  interest,  limited  as  hereinbefore  explained. 

Moreover,  the  amount  of  any  indebtedness  secured  by  such  col- 
lateral is  not  to  be  included  in  the  statement  of  interest-bearing  in- 
debtedness outstanding  at  the  close  of  the  year  for  the  purpose  of  as- 
certaining the  maximum  principal  on  which  the  general  interest  de- 
duction can  be  computed. 


132  THE    INCOME   TAX 

Indebtedness  secured  by  such  collateral  stands  by  itself,  and  the 
entire  amount  of  interest  paid  on  it  is  deductible  as  an  expense  of  do- 
ing business,  subject  only  to  the  statute's  limitation  that  ''interest  on 
such  indebtedness  shall  only  be  deductible  on  an  amount  of  such  in- 
debtedness not  in  excess  of  the  actual  value  of  such  property  col- 
lateral." 

In  other  words,  the  amount  of  interest  paid  on  such  indebtedness 
does  not  go  into  a  return  of  income  as  a  part  of  the  general  deduction 
for  interest,  but  does  go  in  as  one  of  the  items  of  general  expenses, 
along  with  such  other  items  as  expenditures  for  labor,  fuel,  power, 
rent,  repairs  and  the  like. 

259.— WHAT  COLLATERAL  IS  MEANT? 

Naturally,  the  first  question  that  occurs  to  the  taxpayer  is : 
"What  collateral  is  meant  to  be  included  and  what  character  of  loan 
comes  within  the  indebtedness  referred  to  and  favored  by  the 
statute?" 

The  Department  has  gone  to  some  pains  to  explain  the  law  and  to 
emphasize  its  insistence  upon  a  very  close  adherence  to  the  exact 
language  of  the  Act. 

"Collateral,"  as  used  in  this  connection,  the  Department  holds, 
comprehends  any  form  of  property  bound  for  the  payment  of  an  obli- 
gation. 

The  basic  requirement  is  that  the  property  shall  be  the  subject  of 
sale  or  hypothecation  in  the  ordinary  business  of  the  corporation  as  a 
dealer  only  in  the  property  constituting  the  collateral,  or  in  loaning 
the  funds  procured. 

A  corporation  engaged  exclusively  in  buying,  selling  and  dealing 
in  the  particular  kind  of  property  which  is  pledged  for  the  obligation 
is  entitled  to  deduction  of  the  amount  of  interest  paid  as  an  expense 
of  doing  business. 

In  the  case  of  a  corporation  engaged  exclusively  in  dealing  in  real 
estate,  the  collateral,  referred  to  in  the  law,  would  be  the  real  estate 
which  it  might  mortgage  to  protect  indebtedness.  However,  in  this 
connection,  attention  is  called  to  a  limitation  imposed  by  the  Depart- 
ment in  Treasury  Decision  2137,  which  reads  as  follows  : 

Real  estate  to  constitute  collateral  within  the  meaning  of  this 
clause  of  the  law  must  be  such  real  estate  as  is  in  fact  the  subject  of 
sale  in  the  ordinary  business  of  the  corporation.  If  the  corporation 
whose  ordinary  business  is  the  purchase  and  sale  of  real  estate  has  an 
office  building  under  mortgage,  which  office  building  is  not  subject  to 
sale  in  the  ordinary  business  of  the  corporation,  the  interest  paid  on 
such  mortgage  will  not  be  deductible  [as  an  expense  of  doing  business.] 


THE   INCOME   TAX  133 

And  again  in  Treasury  Decision  1993  the  Department  has  held 
that  the  law 

does  not  authorize  the  deduction  as  "an  expense  of  doing  business" 
of  any  interest  paid  on  indebtedness  secured  by  property,  real  or  per- 
sonal, which  is  not  the  "subject  of  sale  in  the  ordinary  business  of  the 
corporation,"  but  which  is  held  by  it  for  the  purpose  of,  or  as  an  instru- 
ment in  carrying  on,  its  ordinary  business — such  as  the  rights  of  way 
and  other  property  of  public  utility  companies,  permanent  office  build- 
ings and  property  of  like  character  held  or  occupied  for  their  own  par- 
ticular use  or  purpose  in  the  furtherance  of  the  objects  of  the  corpora- 
tion, but  which  property  is  not  the  subject  of  sale  in  the  ordinary  busi- 
ness, and  which  is  simply  occupied  or  used  as  an  instrument  or  means 
of  or  essential  to  carrying  on  of  the  ordinary  business  for  the  transac- 
tion of  which  they  are  organized.  The  fact  that  such  property  may  be 
subject  to  sale  under  extraordinary  or  peculiar  conditions  does  not 
qualify  but  rather  disqualifies,  it  as  "collateral"  such  as  is  contem- 
plated by  the  provision  of  the  act  cited. 

The  meaning  of  the  law  must  be  apparent.  Each  corporation  will 
have  to  work  the  matter  out  for  itself,  but  in  doing  so  will  be  required 
to  furnish  data  in  a  supplementary  statement  made  a  part  of  its  re- 
turn of  income.  The  character  of  the  property  collateral  and  the  re- 
lation of  the  property  to  the  ordinary  business  of  the  corporation  are 
the  controlling  considerations. 

260.— TAX-FREE  COVENANT  IN  BONDS. 

With  reference  to  the  issuance  of  bonds  (Part  5,  above)  by  cor- 
porations with  a  guaranty  that  the  interest  paid  on  them  shall  be  free 
from  taxation,  the  position  of  the  Government  is  really  that  of  an 
outside  party.  The  stipulation  in  the  bonds  is  a  contract  wholly  be- 
tween the  corporation  and  the  bondholder,  insists  the  Treasury  De- 
partment. The  interest  paid  is  subject  to  tax  in  the  hands  of  the 
bondholder  the  same  as  any  other  interest,  and  the  amount  of  it 
enters  into  determination  of  the  bondholder's  liability.  In  the  case  of 
bonds  of  this  character,  when  no  ownership  certificate  claiming  ex- 
emption is  filed  by  the  bondholder,  the  corporation  withholds  the  nor- 
mal tax  and  reports  and  pays  such  withholding  to  the  Collector  as  tax 
withheld  on  payments  of  interest  to  the  holders  of  its  bonds.  The 
bondholders  then  account  for  the  amount  of  interest  as  income  which 
has  been  taxed  at  the  source.  In  no  circumstances  is  the  tax  on  such 
interest  allowable  as  a  deduction  in  arriving  at  the  amount  of  tax  due 
on  the  income  of  the  corporation. 

261.— INTEREST  PAID  BY  BANKS. 

The  interest  paid  by  a  bank  (Part  6,  above)  on  deposits  or  on 
money  received  by  it  for  investment  and  secured  by  interest-bearing 
certificates  of  indebtedness  issued  by  the  bank  is  deductible  in  full 
without  reference  to  the  limitation  with  respect  to  amount  of  capital 


134  THE   INCOME   TAX 

and  interest-bearing  indebtedness  outstanding  at  the  close  of  the 
year.  In  the  form  on  which  a  corporation  is  required  to  file  return 
will  be  found  a  special  line  for  the  deduction  of  this  item.  In  other 
words,  a  banking  corporation  should  state  the  item  separately  and  not 
add  it  either  to  the  general  interest  deduction  or  to  the  expense  of  do- 
ing business. 

F.— DEDUCTION  OF  TAXES 

In  the  first  place,  a  tax,  to  be  deductible  in  a  corporation's  return 
must  have  been  actually  paid  during  the  year  for  which  the  return  is 
made.  A  reserve  for  taxes  is  not  allowable  as  a  deduction.  The  lan- 
guage of  the  law,  "taxes  paid,"  can  have  only  one  interpretation. 

Exceptions  in  Law. 

The  law  mentions  three  exceptions : 

(a)  Federal  Income  Tax. 

(b)  Federal  Excess  Profits  Tax. 

(c)  Taxes  assessed  against  local  benefits. 

Denial  of  the  right  to  deduct  the  amounts  paid  the  Government 
as  Income  and  Excess  Profits  taxes  was  written  into  the  law  by 
amendments  carried  by  the  War  Revenue  Act  of  October  3,  1917. 
Prior  to  such  amendment  the  Federal  Income  tax  could  be  included  in 
the  deduction  for  taxes  ;  but  not  now.  However,  this  exclusion  of  the 
Federal  Income  tax  from  the  deduction  does  not  apply  to  the  income 
tax  imposed  by  any  State.  It  is  limited  to  the  Federal  tax. 

The  Federal  excess  profits  tax  is  not  allowable  as  a  deduction  for 
taxes  and  in  the  determination  of  net  income,  as  "net  income"  is  de- 
fined in  Paragraph  1  of  Chapter  II.  The  law  provides,  however,  that 
in  assessing  income  tax  the  amount  of  net  income,  ascertained  with- 
out allowancce  of  any  excess  profits  tax  paid  as  a  deduction,  is  to  be 
credited  with  the  amount  of  excess  profits  tax  assessed  for  the  same 
tax  year. 

A  tax  assessed  against  a  local  benefit  has  been  hereinbefore  ex- 
plained. See  paragraph,  "Taxes  Against  Local  Benefits,"  in  instruc- 
tions to  individuals  relative  to  the  deductions  allowed  them. 

Exceptions  by  Regulation. 

But  the  Department  has  held  that  certain  other  taxes  paid  by  cor- 
porations are  not  deductible. 

The  State  Inheritance  Tax  is  not  deductible,  because  it  is  charge- 
able to  the  corpus  of  the  estate.  It  is  not,  therefore,  to  be  deducted 


THE   INCOME   TAX  135 

either  in  the  return  of  income  of  the  executor  of  the  estate  or  in  the 
return  of  income  of  the  beneficiaries. 

Taxes  paid  by  a  banking  corporation  for  its  shareholders  upon  its 
capital  stock  are  not  deductible.  This  tax  cannot  be  deducted  by  the 
bank  but  can  be  deducted  by  the  shareholders.  This  exclusion  does 
not,  however,  extend  to  an  excise  or  franchise  tax  imposed  upon  the 
banking  corporation  itself  and  required  to  be  paid  to  the  State  as  a 
condition  of  doing  business. 

No  tax  paid  by  a  corporation  pursuant  to  a  covenant  in  its  bonds 
guaranteeing  that  the  interest  on  such  bonds  shall  be  free  from  taxa 
tion  can  be  deducted.  The  Government,  as  hereinbefore  explained,  re- 
gards such  a  covenant  only  as  an  agreement  between  the  corporation 
and  its  bondholder,  and  tax  liability  with  respect  to  the  interest  as  in- 
come remains  the  liability  of  the  recipient  of  the  interest,  the  bond- 
holder, notwithstanding  the  guaranty  in  the  bond. 

With  the  exceptions  noted,  taxes  are  deductible  in  the  corpora- 
tion's return  for  the  full  amount  paid  during  the  year — not  for  the 
full  amount  assessed,  but  for  the  full  amount  actually  paid. 

262.— PECULIAR  INSURANCE  DEDUCTIONS. 

The  law  takes  cognizance  of  items  of  deduction  peculiar  to  the 
insurance  business  and  makes  allowance  for  them.  With  respect  to 
these  special  deductions  it  provides 

for  an  allowance,  in  the  case  of  insurance  companies,  of 
the  net  addition,  if  any,  required  by  law  to  be  made  within 
the  year  for  which  the  return  is  made  to  reserve  funds  and 
the  sums  other  than  dividends  paid  within  the  year  on  policy 
and  annuity  contracts. 

There  are,  however,  several  distinct  provisos  with  reference  to 
the  income  of  various  kinds  of  insurance  companies.  They  are  as  fol- 
lows : 

(a)  Mutual  fire,  mutual  employers'  liability,  mutual 
workmen's  compensation  and  mutual  casualty  insurance 
companies,  which  require  their  members  to  make  premium 
deposits  to  provide  for  losses  and  expenses,  should  not  include 
in  a  return  of  income  any  portion  of  the  premium  deposits  re- 
turned to  their  policyholders,  but  must  return  for  taxation  all 
income  received  by  them  from  all  other  sources  plus  such 
portions  of  the  premium  deposits  as  are  retained  by  the  com- 
panies for  any  purpose  other  than  the  payment  of  losses  and 
expenses  and  re-insurance  reserves. 


136  THE    INCOME    TAX 

(b)  Mutual    marine    insurance     companies    must    make 
their  statement  of  gross  income  in  a  return  of  income  include 
gross  premiums  collected  and  received  less  amounts  paid  for 
reinsurance.     Against  this  gross  they  are  allowed  as  deduc- 
tions any  amounts  repaid  to  policyholders  on  account  of  pre- 
miums previously  paid  by  such  policyholders  and  any  interest 
paid  upon  such  amounts  (paid  to  policyholders)  between  as- 
certainment and  payment. 

(c)  Life  insurance  companies  should  not  include  in  a  re- 
turn for  any  year  "such  portion   of   any   actual  premium  re- 
ceived  from   any    individual  policyholder  as  shall  have  been 
paid  back  or  credited  to  such  individual  policyholder,  or  treat- 
ed as  an  abatement  of  premium    of    such    individual    policy- 
holder,  within  the  year." 

Insurance  Reserves. 

Referring  to  the  special  deductions  provided  for,  the  Treasury 
Department  has  held  that  the  reserve  fund  of  an  insurance  company 
to  be  considered  in  ascertaining  the  "net  addition  to  reserve  funds," 

deductible  under  the  law,  shall  include  only  the  reinsurance  reserve 
and  the  reserve  for  supplementary  contracts  required  by  law  in  the 
case  of  life  insurance  companies,  the  unearned  premium  reserves  re- 
quired by  law  in  the  case  of  fire,  marine,  accident,  liability,  and  other 
insurance  companies,  and  such  other  reserves  as  are  specifically  re- 
quired by  the  laws  of  the  State  in  which  the  insurance  company  is  en- 
gaged in  business.  There  must  not  be  included  the  reserve  on  any 
policy  the  premiums  on  which  have  not  been  accounted  for  in  gross 
income.  By  "Net  Addition"  is  meant  the  excess  of  the  reserve  at  the 
end  of  the  year  over  that  at  the  beginning  of  the  year.  In  the  case  of 
?ssessment  insurance  companies,  any  amount  actually  deposited  with 
a  State  officer  in  compliance  with  law,  as  an  addition  to  a  reserve  or 
guaranty  fund,  is  allowable  in  the  computation  of  the  deductible  "net 
addition." 

Payments  on  Policies. 

In  the  return  form  heretofore  used  special  place  was  provided  for 
the  deduction  of  payments  on  policies  (distinct  from  all  other  deduc- 
tions). Thus  deduction  is  allowed,  according  to  Departmental  ruling, 
for  all  death,  disability,  or  other  policy  claims,  including  fire,  accident, 
and  liability  losses,  matured  endowments,  annuities,  payments  on  in- 
stallment policies,  surrender  values,  and  all  claims  actually  paid  under 
the  terms  of  policy  contracts.  If  salvage  is  deducted  in  ascertaining 


THE    INCOME   TAX  137 

the  net  amount  paid  for  losses,  it  is  not  required  to  be  included  in  gross 
income.  But  the  losses,  to  be  deductible,  must  have  been  actually 
paid.  Reserves  covering  liabilities  for  losses,  incurred  but  not  paid, 
cannot  be  deducted. 

263.— DEDUCTIONS  OF  FOREIGN  CORPORATION. 

A  foreign  corporation  is  entitled  to  deduct  from  its  gross  income 
received  from  all  sources  within  the  United  States  during  the  year 
for  which  the  return  is  made  all  the  items  of  deduction  allowed  cor- 
porations in  general,  except  that  such  deductions  must  be  limited  to 
expenditures  or  charges  incurred  in  connection  with  its  interests  in 
the  United  States — in  other  words,  must  be  immediately  related  to  its 
receipt  of  income  from  sources  within  the  United  States.  A  foreign 
corporation  cannot  charge  against  gross  income  from  sources  within 
the  United  States  any  item  of  expenditure  having  to  do  with  its  busi- 
ness or  its  investments  without  the  United  States. 

Operating  expenses,  losses,  depreciation  and  depletion  allowances 
are  deductible,  provided  they  relate  to  the  business  and  property  of 
the  foreign  corporation  within  the  United  States. 

All  the  deductions  peculiar  to  corporations  engaged  in  the  insur- 
ance business  are  allowable  to  foreign  corporations  with  respect  to 
insurance  business  conducted  by  them  in  the  United  States. 

Interest  is  deductible  by  a  foreign  corporation  according  to  a 
method  specifically  provided  in  the  law,  as  follows : 

The  amount  of  interest  paid  within  the  year  on  its  indebtedness 
(except  on  indebtedness  incurred  for  the  purchase  of  obligations  or  se- 
curities the  interest  upon  which  is  exempt  from  taxation  under  this  title) 
to  an  amount  of  such  indebtedness  not  in  excess  of  the  proportion  of 
the  sum  of  (a)  the  entire  amount  of  the  paid-up  capital  stock  outstand- 
ing at  the  close  of  the  year,  or  if  no  capital  stock,  the  entire  amount  of 
the  capital  employed  in  the  business  at  the  close  of  the  year,  and  (b) 
one-half  of  its  interest-bearing  indebtedness  then  outstanding,  which 
the  gross  amount  of  its  income  for  the  year  from  business  transacted 
and  capital  invested  within  the  United  States  bears  to  the  gross  amount 
of  its  income  derived  from  all  sources  within  and  without  the  United 
States. 

To  apply  the  above  prescribed  method  a  foreign  corporation 
should  add  to  the  amount  of  its  paid-up  capital  stock,  or  if  no  capital 
stock,  then  the  amount  of  capital  employed  in  its  business,  one-half 
of  its  interest-bearing  indebtedness,  both  capital  stock  and  indebted- 
ness outstanding  at  the  close  of  the  year.  If  its  gross  income  from 
the  United  States  is  one-third  of  its  entire  gross  income,  then  one- 
third  of  the  above  sum  obtained  by  adding  to  paid-up  capital  stock 
one-half  of  interest-bearing  indebtedness,  is  the  maximum  principal 
upon  which  deductible  interest  may  be  computed. 


138  THE   INCOME   TAX 

In  the  case  of  a  bank,  interest  paid  within  the  year  on  deposits  by 
or  on  money  received  for  investment  from  either  citizens  or  residents 
of  the  United  States  is  deductible  in  full,  as  in  the  case  of  a  domestic 
banking  corporation,  and  separately  from  the  general  deduction  for 
interest  as  limited  by  paid-up  capital  stock  and  interest-bearing  in- 
debtedness. 

With  respect  to  taxes  a  foreign  corporation  is  limited  in  its  de- 
duction to  taxes  paid  within  the  United  States.  It  is  not  allowed 
deduction  for  a  tax  imposed  by  a  foreign  country,  as  is  a  domestic 
corporation.  The  reason  for  this  is  obvious.  A  domestic  corporation 
must  account  for  income  from  all  sources,  a  foreign  corporation  only 
for  income  from  sources  within  the  United  States. 


THE   INCOME   TAX  139 


CHAPTER  XVII 


THE  INCOME  TAX 


DEPRECIATION   OF   PHYSICAL  PROPERTY. 


264.— DEPRECIATION  DEFINED. 

The  income  tax  law  allows  a  deduction  from  gross  income  on  ac- 
count of  the  depreciation  of  physical  property  due  to  exhaustion,  wear 
and  tear  in  the  use  of  the  property  in  the  business  or  businesses  of  the 
taxpayer.  It  also  allows  a  deduction  on  account  of  obsolescence, 
which  will  be  explained  hereinafter. 

The  deduction  for  depreciation,  made  and  claimed  in  a  return  of 
annual  net  income,  is  supposed  to  be  the  amount  of  the  loss,  incurred 
during  the  year  for  which  the  return  is  made,  in  the  value  of  the  prop- 
erty— a  loss  which  has  not  been  made  good  by  expenditures  for  ordi- 
nary repairs  and  maintenance  during  the  year — a  loss  representing  an 
appreciable  deterioration  in  value  as  a  business  property,  even  though 
such  property  may  have  been  repaired  from  time  to  time  to  keep  it  in 
operation. 

265.— BASIS  OF  DEPRECIATION. 

Manifestly  a  deduction  on  account  of  depreciation  is  an  estimate, 
but  if  instructions  are  followed  this  estimate  may  be  made  very  nearly 
accurate.  The  claim  for  allowance  should  be  based  upon  the  assumed 
life  of  the  property,  its  cost  and  the  use  to  which  it  is  put.  First  must 
be  considered  the  cost,  as  it  is  this  cost  which  the  law  contemplates 
shall  be  covered  eventually  by  the  aggregate  of  annual  allowances ; 
then,  should  be  ascertained  the  probable  number  of  years  constituting 
the  life  of  the  property,  for  it  is  over  such  a  period  that  the  loss  due  to 
depreciation  is  sustained.  In  other  words,  the  cost  of  the  property, 
for  the  purpose  of  arriving  at  a  proper  deduction  for  depreciation, 
should  be  ratably  spread  over  its  life. 


140  THE    INCOME   TAX 

That  the  position  of  the  Treasury  Department  may  be  set  forth 
clearly  with  respect  to  this  allowance,  the  ruling  made  in  an  official 
letter  of  the  Department  is  quoted.  Such  ruling  is  as  follows  : 

The  amount  of  the  allowable  depreciation  deduction  should  be 
credited  to  a  depreciation  reserve  account,  against  which  account  will 
be  charged  the  cost  of  renewing  or  replacing  the  property  with  respect 
to  which  the  depreciation  is  claimed. 

It  is  not  contemplated  that  such  ordinary  incidental  repairs  as  keep 
the  property  in  an  operating  condition  shall  be  charged  to  this  deprecia- 
tion reserve  but  such  cost  may  be  charged  to  the  expense  of  operation 
and  maintenance.  In  other  words,  the  depreciation  deduction  is  intend- 
ed to  provide  a  fund  out  of  which  the  loss  due  to  depreciation  occa- 
sioned by  use,  wear  and  tear,  may  be  made  good. 

This  office  recognizes  the  fact  that  a  building  or  a  piece  of  ma- 
chinery or  other  equipment,  as  a  whole,  may  deteriorate  in  value  and 
usefulness  by  reason  of  wear  and  tear,  regardless  of  the  fact  that  cer- 
tain minor  component  parts  may  be  renewed,  restored  or  replaced.  The 
depreciation  deduction  authorized  by  the  law  therefore  contemplates 
the  creation  of  a  fund  that  will  renew,  restore  or  replace  the  original 
property  when  it  has  become  worn  out  or  exhausted,  regardless  of  the 
renewal  and  restoration  of  parts  that  may  have  been  made  in  the  mean- 
time. 

Hence  it  is  held  that  in  addition  to  the  depreciation  deduction  in- 
tended to  cover  the  cost  of  the  property  as  a  whole,  the  expense  of  in- 
cidental repairs  which  do  not  add  to  the  value  of  the  property  but 
merely  keep  it  in  an  operating  condition,  may  be  allowably  deducted 
from  gross  income  as  an  expense  of  operation  and  maintenance. 

It  is  barely  possible  in  some  instances  that  worn-out  parts  of  a  ma- 
chine or  similar  equipment  may  be  renewed  one  after  another  until  the 
original  machine  or  equipment  is  swallowed  up  in  the  renewed  parts 
and  the  machine  or  equipment  is  then  in  as  good  operating  condition  as 
it  originally  was.  In  this  case,  if  the  cost  of  renewal  parts  is  charged 
to  operating  expense,  no  deduction  on  account  of  depreciation  should 
be  claimed  or  allowed  as  to  such  machine  or  equipment. 

This  would  appear  to  be  true  in  the  case  of  pipe  lines,  worn-out 
pipe  covering  and  similar  articles  of  equipment.  By  replacing  one  joint 
of  pipe  after  another,  all  may  be  replaced,  and  if  the  expense  is  deduct- 
ed as  an  operating  expense,  any  depreciation  fund  that  may  have  been 
reserved  for  the  purpose  of  restoring  the  pipe  line  as  a  whole  will  re- 
main unused. 

So  that  in  oases  of  this  kind,  if  a  depreciation  reserve  is  set  up  to 
cover  property  that  may  be  renewed  or  restored  part  by  part,  until  the 
whole  s  renewed,  the  cost  of  the  renewed  parts  should  be  charged  to 
the  depreciation  reserve  fund  and  will  not  be  considered  incidental  ex- 
penses within  the  meaning  of  the  regulations. 

"Incidental  repairs"  refers  only  to  those  repairs  which  are,  as  the 
term  signifies,  only  incidental  to  the  operation  of  the  property  and 
which  will  not,  if  continued  as  the  component  parts  wear  out  and  are 
restored,  make  permanent  the  property. 

Hence  the  depreciation  deduction  allowable  with  respect  to  any 
property,  is  such  an  amount  as,  in  the  aggregate,  when  the  property  as 
a  whole  is  worn  out,  will  replace  it  or  return  to  the  corporation  (or  in- 
dividual) the  capital  invested  in  it.  That  is  to  say,  the  depreciation  de- 
duction allowable  under  the  law  and  the  regulations,  should  be  only 
such  an  amount  as  will  take  care  of  loss  due  to  the  general  wear  and 
tear,  and  which  is  to  no  extent  compensated  by  expenditures  made  for 
repairs. 

It  is  the  opinion  of  this  office  that  expenditures  for  replacing  worn- 
out  parts  such  as  gears,  bolts,  nuts,  valves,  etc.,  so  long  as  such  replace- 
ments are  not  pursued  to  the  extent  and  for  the  purpose  of  finally  re- 
storing the  machinery  or  equipment  as  a  whole,  constitute  incidental 


THE    INCOME   TAX  141 

repairs,  and  expenditures  of  this  character  are  deductible  from  gross 
income  as  an  operating  expense,  the  depreciation  deduction  with  re- 
spect to  the  property  so  repaired  being  reserved  to  replace  the  ma- 
chinery, equipment  or  building  when,  as  an  entirety,  it  is  worn  out  or 
is  worthless  for  the  purpose  for  which  it  is  intended. 

Such  is  the  statement  of  the  Department's  position,  and  it  is 
strictly  adhered  to  by  both  the  auditing  and  the  investigating  officers 
under  whose  scrutiny  returns  of  income  must  pass.  It  is  a  general 
regulation  with  respect  to  all  physical  property  employed  in  business. 

There  will,  however,  arise  problems  that  cannot  be  solved  by  ap- 
plication of  general  rules.  The  percentage  system  is  not  a  part  of  the 
law  ;  it  is  merely  prescribed  by  Departmental  rules.  And  so,  in  cir- 
cumstances when  the  rules  are  not  applicable,  it  is  suggested  that  the 
taxpayer  may  fall  back  upon  the  provision  of  law  allowing  a  reason- 
able deduction  for  depreciation.  If  the  taxpayer  can  show  that  his  de- 
duction is  reasonable,  he  is  within  his  legal  rights,  and  cannot  be 
penalized  for  asserting  them. 

266.— OBSOLESCENCE. 

However,  with  respect  to  deterioration  in  value  on  account  of 
obsolescence  a  different  rule  must  be  followed.  That  loss  is  sustained 
by  such  deterioration  cannot  be  denied.  Such  a  loss,  however,  is  de- 
ductible as  a  loss  and  not  according  to  the  rule  of  annually  claiming  a 
year's  percentage  of  the  cost  of  the  property.  Regarding  a  loss  of 
this  kind  the  Department  has  plainly  stated  its  position  as  follows  : 

It  is  not  possible  in  advance  to  determine  when  a  piece  of  ma- 
chinery, equipment,  or  even  a  building  will  become  obsolete.  In  other 
words,  obsolescence  cannot  be  anticipated  and  an  annual  deduction  to 
take  care  of  possible  obsolescence  cannot  be  allowed. 

The  rules  of  this  office  contemplate  that  annual  deductions  for  de- 
preciation may  be  made  to  provide  for  loss  due  to  wear  and  tear,  the 
amount  of  such  deduction  to  be  determined  upon  the  basis  of  the  prob- 
able life  of  the  property.  If  it  shall  occur  that  the  property  becomes 
obsolete  or  worthless  before  its  estimated  probable  life  shall  have  ex- 
pired, a  deduction  representing  the  difference  between  the  cost  of  the 
property  and  the  amount  previously  charged  off  on  account  of  deprecia- 
tion may  be  deducted  as  a  loss,  this  amount  being  a  deduction  due  to 
the  obsolescence  of  the  property. 

267.— MUST  APPEAR  ON  BOOKS. 

There  has  been  a  great  deal  of  controversy  between  taxpayers 
and  the  Government  relative  to  a  requirement  in  the  rulings  of  the 
Treasury  Department  to  the  effect  that  the  annual  allowance  for  de- 
preciation shall  be  charged  off  on  the  books  of  the  taxpayer  (corpora- 
tion or  individual)  so  as  to  constitute  a  liability  against  assets.  Cer- 
tain corporations  have  contended  that  there  is  nothing  in  the  law — 
and  that  legally  nothing  can  be  written  into  departmental  regula- 


142  THE    INCOME   TAX 

tions — requiring  that  a  corporation  keep  its  accounts  by  any  particu- 
lar method. 

In  extensive  correspondence  the  Department  has  argued  that  the 
loss  allowed  for  depreciation  is  supposed  to  be  a  real  loss,  and,  as  such, 
must,  of  reason,  be  taken  regularly  into  the  accounts  of  the  taxpayer ; 
that,  if  it  is  not  a  loss  entitled  to  such  consideration,  it  is  not  of  the 
character  that  constitutes  a  legitimate  deduction  in  a  return  of  in- 
come. In  effect,  says  the  Department  to  the  officers  of  a  corporation, 
if  the  loss  you  claim  on  account  of  depreciation  is  not  real  enough  to 
reflect  to  your  stockholders,  it  is  not  real  enough  to  have  the  approval 
of  the  Government  as  a  charge  against  gross  income. 

And  so  the  Department,  in  its  instructions  to  field  officers  has 
ruled  that  where  a  claim  for  loss  on  account  of  depreciation  is  found 
to  be  reasonable  but  not  to  have  been  entered  upon  the  books  of  the 
taxpayer,  opportunity  should  be  given  the  taxpayer  to  reopen  the 
books  and  make  proper  entries  to  the  end  that  the  amount  of  the  an- 
nual depreciation  shall  constitute  a  liability  against  the  assets  of  the 
taxpayer  and  a  charge  against  the  income  of  the  year  for  which  the 
return  is  made.  If  the  taxpayer  refuses  to  make  the  proper  entries, 
field  officers  are  directed  to  disallow  the  amount  claimed  as  a  deduc- 
tion on  account  of  depreciation. 

Moreover,  the  Department  holds  that  a  mere  Journal  entry  is  not 
sufficient,  insisting  upon  a  general  ledger  entry  of  the  amount  charged 
off  and  the  reflection  of  the  amount  so  charged  in  the  annual  Balance 
Sheet  and  in  the  report  to  stockholders. 

268.— NO  FIXED  PERCENTAGES. 

The  law  does  not  fix  the  annual  percentage  of  depreciation  with 
respect  to  any  kind  of  physical  property ;  neither  do  the  regulations 
of  the  Department.  But  the  Department  does  reserve  to  itself  the 
right  to  pass  upon  the  reasonableness  of  every  deduction  for  deprecia- 
tion under  the  requirement  of  the  statute  that  the  deduction  shall  be 
for  a  "reasonable  allowance." 

And,  likewise,  the  taxpayer  has  a  right  to  express  his  opinion 
with  regard  to  what  is  reasonable. 

The  estimated  life  of  the  property  (the  probable  number  of  years 
it  will  remain  so  as  to  be  usable  for  the  general  purposes  for  which  it 
was  intended)  is  one  consideration ;  the  other,  the  cost. 

Only  so  far  do  the  regulations  of  the  Department  go. 

During  the  early  years  of  income  tax  administration  certain  esti- 
mated percentages  of  depreciation  announced  by  the  San  Francisco 


THE   INCOME   TAX  143 

Real  Estate  Board  were  followed  by  Internal  Revenue  Officers  in 
checking  returns  filed  in  California,  and  were  approved  by  the  Treas- 
ury Department.  However,  when  the  Department  began  the  final 
audit  of  the  returns  filed  for  the  year  1915  it  reduced  the  percentage 
claimed  by  a  great  many  taxpayers — reduced  the  percentage,  in 
numerous  cases,  until  the  allowance  was  rankly  unreasonable,  as  far 
as  the  rights  of  the  taxpayer  were  concerned. 

The  estimated  rates  of  depreciation  fixed  by  the  San  Francisco 
Real  Estate  Board,  above  referred  to,  are  as  follows : 

Class  A  buildings 2  per  cent  per  annum. 

B  2l/2  per  cent  per  annum. 

C  3l/%  per  cent  per  annum. 

269.— SUGGESTION  TO  TAXPAYER. 

It  is  suggested  that  the.  taxpayer,  bearing  in  mind  the  factors  of 
cost  and  probable  life,  claim  what  seems  right  and  fair  and  "reason- 
able." There  can  be  no  penalty  imposed  for  such  an  assertion  of  what 
one  believes  to  be  his  right.  Subsequently  the  Department  may  dis- 
agree and  disapprove,  but  even  then  the  taxpayer  still  has  the  right  of 
argument. 

If  the  deduction  on  account  of  depreciation  is  reduced  by  the  De- 
partment to  an  amount  so  small  as  to  appear  to  the  taxpayer  un- 
reasonable, and  if  as  a  result  of  the  alteration  of  the  return  increased 
assessment  is  made,  the  taxpayer  may  again  present  his  conten- 
tion in  the  form  of  a  claim  for  the  abatement  of  the  assessment.  (See 
"Claims  for  Abatement  and  Refund.") 

270.— COURT  DEFINITION  OF  DEPRECIATION. 

In  order  that  the  taxpayer  may  have  the  benefit  of  a 
judicial  statement  on  this  subject  the  opinion  of  the  Court  in  the  case 
of  Hyman  Cohen  v.  John  Z.  Lowe,  Collector,  in  the  District  Court  of 
the  United  States  for  the  Southern  District  of  New  York  (234  Fed. 
474)  is  herewith  quoted.  Said  the  Court : 

The  plaintiff  was  allowed  3  per  cent  for  depreciation  on  an  apart- 
ment house  owned  by  him.  This  allowance  is  for  the  wear  and  tear 
suffered  by  the  building  during  the  tax  year,  which  means  the  physical 
deterioration  that  the  building  suffered  during  that  period.  It  does  not 
take  into  account  depreciation  in  value  due  to  a  loss  in  rental  value  be- 
cause of  the  construction  of  more  modern  buildings  with  improved 
facilities,  or  due  to  a  change  in  the  neighborhood.  It  is  to  be  based 
upon  the  life  of  the  building  in  the  sense  of  the  number  of  years  the 
building  would  remain  in  a  condition  to  be  habitable  for  the  use  for 
which  it  was  constructed  and  used,  and  which  was  in  the  instant  case 
for  an  apartment  house,  and  not  merely  the  number  of  years  it  would 


144  THE    INCOME   TAX 

stand  without  being  condemned  and  torn  down.  The  annual  deprecia- 
tion would  be  an  amount  represented  by  a  fraction  having  one  (tax 
year)  for  the  numerator  and  the  number  of  years,  representing  the  as- 
certained life  of  the  building,  as  the  denominator.  This  assumes  that 
there  would  be  an  average  deterioration  suffered  each  year  during  the 
life  of  the  building,  and  that  the  plaintiff  would  keep  the  building  in 
good  repair  during  the  life  of  it.  This  the  law  exacts  of  him.  Upon 
these  assumptions,  and  giving  this  meaning  to  the  words  of  the  Stat- 
ute, "a  reasonable  allowance  for  the  exhaustion,  wear  and  tear  of  the 
property,  arising  out  of  its  use  or  employment  in  the  business,"  the 
amount  of  the  deduction  allowed  by  the  Government  to  the  plaintiff  on 
this  account  is  deemed  to  be  reasonable. 

271.— NO  DEPRECIATION  OF  REAL  ESTATE. 

The  Treasury  Department  does  not  allow  a  deduction  from  gross 
income  for  depreciation  of  real  estate.  Real  estate,  it  holds,  is  not 
property  of  the  character  affected  by  use,  wear  and  tear.  The  life  of 
it  runs  on  forever. 

True,  as  in  the  case  of  farming  land  which  is  intensively  cultivat- 
ed, productivity  will  decrease  unless  there  be  a  replenishment  of  cer- 
tain elements  exhausted  from  the  soil,  but,  as  every  farmer  knows, 
this  replenishment  is  accomplished  by  the  rotation  of  crops,  the 
growth  and  plowing  under  without  harvest  of  plants  rich  in  the  weak- 
ening elements,  or  by  the  use  of  fertilizers ;  and  when  renewal  and 
restoration  are  effected  by  plowing  under  of  plants  or  the  use  of  ferti- 
lizers, the  cost  of  the  operation  and  of  the  seeds  and  fertilizing  ma- 
terials used  is  deductible  as  an  expense  of  operation.  Consequently, 
deduction  cannot  be  claimed  for  depreciation  of  the  land. 

In  the  case  of  improved  property,  that  is  real  estate  with  build- 
ings on  it,  some  difficulty  is  experienced  in  certain  circumstances.  A 
case  in  point  would  be  the  purchase  of  a  business  building  and  the  land 
on  which  it  stands  for  $250,000,  without  any  division  of  the  purchase 
price  being  made  at  the  time  of  purchase  with  respect  to  the  cost  of 
the  building  and  the  cost  of  the  land.  The  Department  would  allow 
depreciation  for  the  building  but  not  for  the  land.  It  becomes  neces- 
sary, therefore,  to  make  a  division  with  respect  to  cost,  arbitrary,  in 
a  sense,  but  based  upon  the  best  available  information. 

272.— DEPRECIATION   OF   LIVESTOCK. 

Depreciation  is  allowed  for  livestock  employed  in  business.  This 
provision  covers  the  working  horses  and  mules  used  on  a  farm,  or  in 
the  livery  or  draying  and  delivery  business — in  fact,  in  any  business 
where  the  working  of  animals  is  a  part  of  the  operation  of  the  busi- 
ness— also  stock  used  for  breeding  purposes. 

In  this  connection,  the  Department  has  held  in  official  letters  deal- 
ing with  individual  cases  that  depreciation  on  animals  used  for  busi- 
ness purposes  is  an  allowable  deduction  provided  the  animals  were  not 


THE    INCOME   TAX  145 

raised  by  the  owner  of  the  business  subsequent  to  January  1,  1913. 
If  raised  subsequent  to  that  date,  the  cost  of  production  will  be  cov- 
ered by  deductions  for  necessary  expenses  of  operation  of  the  busi- 
ness. In  the  case  of  animals  raised  by  the  individual  prior  to  January 
1,  1913,  depreciation  should  be  computed  on  the  fair  market  value  as 
of  that  date,  holds  the  Department,  while,  in  the  case  of  animals  pur- 
chased either  before  or  after  January  1,  1913,  depreciation  should  be 
based  upon  cost. 

273.— DEPRECIATION   OF   TREES   AND  VINES. 

Deduction  for  depreciation  is  also  allowed  the  owner  of  an  or- 
chard or  a  vineyard  on  account  of  the  exhaustion  of  his  trees  or  vines. 
The  method  outlined  by  the  Department  in  letters  dealing  with  indi- 
vidual cases  can  be  stated,  briefly  as  follows : 

Until  an  orchard  or  a  vineyard  reaches  a  productive  stage  the  ex- 
penditures in  connection  with  it  represent  investment  of  capital  and 
no  deduction  in  connection  with  such  property  should  be  taken  up 
to  that  time.  But  when  the  orchard  or  vineyard  reaches  a  productive 
stage,  it  is  proper  to  ascertain  the  cost  of  the  trees  or  vines  as  repre- 
sented by  the  investment  in  them  up  to  that  time.  This  cost,  or  in- 
vestment, is  to  be  ascertained  by  taking  into  consideration  the  pur- 
chase price  of  the  trees  or  vines  at  the  time  of  setting  them  out  and 
all  the  carrying  charges  up  to  the  time  of  bringing  them  to  a  produc- 
tive stage.  The  cost  thus  determined  is  the  basis  on  which  to  com- 
pute depreciation,  the  percentage  of  annual  allowance  to  be  calculated 
according  to  the  average  life  of  the  trees  or  vines. 

Experience  has  shown  that  trees  vary  widely  with  respect  to 
length  of  life.  A  pear  or  an  apple  tree,  or  almond  or  cherry  tree  will 
last  for  a  much  longer  time  than  a  peach  or  apricot  or  prune  or  plum 
tree  ;  and,  likewise  one  kind  of  vine  will  live  and  produce  many  years 
longer  than  another.  No  exact  span  of  life  can  be  fixed.  The  farmer 
can  draAv  upon  his  own  experience,  and  that  of  others,  and  not  be  far 
from  accuracy  in  estimating  the  life  of  his  orchard  or  vineyard.  This 
general  method  is  readily  adaptable  to  any  kind  of  fruit,  grape,  berry 
or  nut  farming. 

274.— DEPRECIATION  OF   PATENTS. 

Allowance  for  depreciation  of  patents  can  be  computed  without 
difficulty.  A  patent  is  good  for  seventeen  years.  Therefore,  if  it  re- 
mains the  property  of  the  patentee,  or  is  acquired  by  another  immedi- 
ately after  having  been  granted,  its  life  is  seventeen  years.  If  it  is  ac- 
quired by  another  than  the  patentee  after  a  part  of  its  period  of  ex- 


146  THE    INCOME   TAX 

elusive  rights  has  expired,  its  life,  insofar  as  investment  of  capital  is 
concerned,  is  the  remaining  portion  of  the  seventeen-year  period. 

The  cost  of  a  patent  to  the  patentee  is  the  amount  actually  ex- 
pended in  perfecting  the  invention  and  obtaining  the  patent — such  ex- 
penditures, for  instance,  as  the  cost  of  drawing,  experiments,  con- 
struction of  models,  and  the  fees,  private  or  official,  incident  to  applica- 
tion for  the  patent. 

The  cost  of  a  patent  to  one  (individual  or  corporation)  who  ac- 
quires it  from  the  patentee  is  the  amount  actually  paid  for  it. 

An  example  of  the  operation  of  the  above  methods  of  computa- 
tion: 

A  patents  a  mechanical  device  and  expends  in  perfecting  his  in- 
vention and  obtaining  patent  the  total  amount  of  $17,000.  He  is  en- 
titled to  deduction  for  depreciation  to  the  amount  of  $1,000  a  year. 

But  if  A  buys  from  B  a  patent  obtained  seven  years  before  by  B 
and  pays  B  $17,000  for  the  patent,  A  is  entitled  to  deduct  one-tenth  of 
the  amount  of  $17,000,  or  $1,700  a  year  on  account  of  depreciation. 

275.— NO  DEPRECIATION  OF  SECURITIES. 

Shrinkage  in  the  value  of  securities  is  not  deductible  as  deprecia- 
tion. The  allowance  for  deduction  on  account  of  depreciation  has 
reference  only  to  those  kinds  of  tangible  property  subject  to  exhaus- 
tion, wear  and  tear  as  a  result  of  use  in  business.  Stocks,  bonds  and 
similar  securities  do  not  come  within  such  a  classification. 

As  explained,  hereinbefore,  with  respect  to  losses  on  stocks  and 
bonds,  such  losses  are  deductible  in  whole  or  in  part,  or  not  at  all,  as 
losses,  and  then  only  when  the  transaction  in  them  meets  the  require- 
ments set  forth  in  detail  in  paragraphs  dealing  with  deductions  for 
losses.  [See  such  paragraphs.] 

276.— NO  DEPRECIATION  OF  MERCHANDISE. 

Also  the  Treasury  Department  holds  that  depreciation  should  not 
be  claimed  on  merchandise  by  a  taxpayer  engaged  in  the  mercantile 
business.  Any  deterioration  in  the  value  of  a  stock  of  goods,  the  De- 
partment has  held  in  the  course  of  its  investigation  of  returns,  may 
be  reflected  in  the  merchant's  inventory  from  year  to  year  and,  there- 
fore, is  not  a  proper  deduction  on  account  of  depreciation. 

277.— NO  DEPRECIATION  OF  GOOD  WILL. 

No  deduction  can  be  claimed  for  depreciation  on  account  of  the 
"good  will"  of  a  business.  "Good  will"  must  be  eliminated  from  con- 
sideration. While  it  undoubtedly  has  a  value,  it  is  held  to  be  such  an 
intangible  asset  that  it  cannot  be  depreciated,  as  physical  property  is 
depreciated,  for  the  purposes  of  the  income  tax.  When  it  is  one  of  the 


THE    INCOME   TAX  147 

assets  of  a  business  such  value  is  over   and   above   the   value   of   the 
physical  property  used  in  the  business. 

278.— WHEN  A  CORPORATION  REORGANIZES. 

If  upon  reorganization  one  corporation  buys  and  takes  over  the 
assets  of  another  corporation,  and  issues  its  own  capital  stock  in  pay- 
ment for  such  assets,  the  actual  value  of  the  property  acquired,  and 
not  the  nominal  par  value  of  the  stock  issued  in  payment  for  it,  is  re- 
garded as  the  cost  to  be  returned  by  allowances  for  depreciation.  An 
example  :  Corporation  A  decides  to  effect  reorganization  by  selling 
and  transfering  to  Corporation  B  (having  the  same  stockholders)  all 
of  its  assets,  such  assets  having  an  actual  value  of  $100,000.  Corpora- 
tion B  issues  in  payment  therefor  stock  of  the  nominal  par  value  of 
$500,000.  In  such  circumstances  the  cost  of  the  property  to  Corpora- 
tion B  is  $100,000,  and  not  $500,000. 

In  such  a  case  the  $500,000  par  value  in  stock  issued  has,  in  real- 
ity, no  greater  value  than  the  assets  of  a  value  of  $100,000,  which,  as 
the  property  of  Corporation  B,  will  support  the  corporation's  stock 
issue. 

279.— INVESTMENT  OF  DEPRECIATION  RESERVE. 

The  problem  of  dealing  with  the  funds  represented  by  deprecia- 
tion reserve  has  seemingly  given  the  Treasury  Department  a  good 
deal  of  concern,  for  there  has  been  a  distinct  reversal  of  its  rulings,  as 
announced  in  the  first  regulations  issued  after  the  enactment  of  the 
Income  Tax  law  of  October  3,  1913.  The  position  originally  taken  by 
the  Department  was  that  the  diversion  of  any  portion  of  the  deprecia- 
tion set  up  to  any  purpose  other  than  making  good  the  loss  sustained 
on  account  of  depreciation  would  necessitate  a  return  for  tax  of  the 
amount  diverted.  Later  in  Treasury  Decision  2137,  this  ruling  was 
amplified  by  a  regulation  to  the  effect  that  the  investment  of  depre- 
ciation reserve  funds  in  additions  to  or  extensions  of  the  taxpayer's 
plant  would  be,  specifically,  such  a  prohibited  diversion  and  would  re- 
sult in  the  requirement  that  the  additional  value  given  to  the  capital 
assets  by  such  investment  be  returned  as  income  subject  to  tax. 

Then  in  official  correspondence  the  Department  modified  its  pro- 
hibition of  investment  in  additions  and  betterments  and  took  the  posi- 
tion that  the  investment  of  depreciation  reserve  funds  in  additions  and 
betterments  should  be  regarded  as  a  conversion  of  the  funds  into  as- 
sets of  another  form  rather  than  a  diversion  of  them,  and  that,  in  the 
event  the  property  with  respect  to  which  the  depreciation  reserve  was 
set  up  is  to  be  renewed  or  replaced,  the  cost  of  such  renewal  or  re- 
placement must  be  paid  out  of  capital  as  distinguished  from  earnings. 


148  THE    INCOME   TAX 

Thus  the  Department  decided  to  allow  the  investment  of  the  deprecia- 
tion reserve  funds  in  additions  and  betterments  to  the  extent  that  the 
amount  so  invested  should  remain  a  liability  against  the  assets  of  the 
taxpayer  and  be  available,  through  conversion  into  cash,  by  bond  issue 
or  otherwise,  to  renew  or  replace  the  property  with  respect  to  which 
the  depreciation  reserve  fund  was  set  up.  With  the  obvious  purpose 
of  putting  its  meaning  into  one  concise  statement  the  Department  on 
April  20,  1915,  ruled  as  follows: 

The  true  intent  and  meaning  of  both  the  original  and  amplified  rul- 
ings is  that  the  depreciation  reserve  set  up  shall  be  a  fair  and  reason- 
able measure  of  the  loss  due  to  use,  wear  and  tear,  shall  be  so  entered 
on  the  books  as  to  constitute  a  liability  against  the  assets  of  the  com- 
pany (or  other  taxpayer)  and  shall  be  available  to  make  good  the  de- 
preciation claimed. 

The  early  treatment  of  this  subject  has  been  briefly  sketched  so 
that  the  taxpayer  may  the  more  readily  grasp  the  meaning  of  the 
present  controlling  ruling,  to  be  found  in  Treasury  Decision  2481,  is- 
sued April  10,  1917,  and  herewith  quoted  as  follows  : 

The  "second"  paragraph  under  Sec.  12  of  Title  I  of  the  Act  of  Sep- 
tember 8,  1916,  authorizes  corporations,  joint-stock  companies,  etc.,  in 
making  their  returns  of  annual  net  income  to  deduct  from  gross  in- 
come  

all  losses  actually  sustained  and  charged  off  within  the  year  *  *  * 
*  *  including  a  reasonable  allowance  for  the  exhaustion,  wear  and  tear 
of  property,  arising  out  of  its  use  or  employment  in  the  business  or 
trade." 

The  essential  requirements  of  this  provision  are  that  the  amount 
deductible  on  account  of  depreciation  and  depletion  shall  be  charged 
off  and  shall  be  reasonable  allowances — that  is,  an  amount  sufficient  to 
make  good  the  loss  due  to  these  causes.  The  phrase  "charged  off" 
contemplates  that  the  "reasonable  allowance"  deducted  from  gross  in- 
come on  account  of  depreciation  or  depletion  shall  be  credited  to  ap- 
propriate reserve  accounts  and  carried  as  a  liability  against  the  assets, 
to  the  end  that  when  the  total  of  these  credits  equals  the  capital  in- 
vestment account,  no  further  deductions  on  these  accounts  will  be 
allowed. 

While  the  presumption  is  that  amounts  credited  to  these  accounts 
will  be  used  to  make  good  the  loss  sustained,  either  through  a  renewal 
or  replacement  of  the  property  or  a  return  of  capital,  there  is  no  re- 
quirement of  law  that  the  funds  represented  by  these  reserve  liabilities 
shall  be  held  intact  or  remain  idle  against  the  day  when  they  may  be 
used  in  making  good  the  depreciation  of  the  property  with  respect  to 
which  the  deduction  is  claimed,  or  in  restoring  the  capital  invested  in 
the  depleted  assets. 

The  conversion  of  the  depreciation  reserve  into  tangible  assets 
will  not  constitute  such  a  diversion  as  would  deny  the  corporation  the 
right  of  deduction,  provided  in  all  cases,  that  the  deduction  claimed  in 
the  return  is  a  reasonable  allowance,  that  is,  a  fair  measure  of  the  loss 
due  to  "exhaustion,  wear  and  tear  of  property,  growing  out  of  its  use" 
and  is  charged  off  or  so  entered  upon  the  books  as  to  constitute  a  lia- 
bility against  the  assets  with  respect  to  which  the  depreciation  deduc- 
tion is  claimed. 


THE    INCOME   TAX  149 


CHAPTER   XVIII 


THE  INCOME  TAX 


DEPLETION   OF   NATURAL   DEPOSITS 


280.— DEPLETION  DEFINED. 

The  Income  Tax  law  also  recognizes  the  loss  due  to  depletion  of 
natural  deposits  in  the  case  of  certain  kinds  of  property  and  makes 
specific  provision  for  taking  care  of  such  loss  and  thereby  returning 
to  the  taxpayer  the  capital  investment  in  the  natural  deposits  which 
are  in  the  end  supposed  to  be  exhausted  by  the  operation  of  the  prop- 
erties. 

Commonly,  such  properties  are  wells,  tapping  supplies  of  oil  or 
gas,  and  mines,  containing  mineral  deposits  in  solid  form.  As  produc- 
tion proceeds,  it  is  obvious  that,  in  the  one  case  the  oil  or  the  gas  flow 
naturally  diminishes  and  that,  in  the  other,  there  must  come  a  time 
when  the  ore  will  all  have  been  extracted.  And  so  the  law  allows  for 
deduction  from  gross  income  on  account  of  such  depletion  of  deposits. 

This  allowance  is  entirely  separate  and  distinct  from  that  cover- 
ing depreciation  of  physical  property.  In  other  words,  the  terms  "de- 
preciation" and  "depletion"  must  not  be  confused.  The  allowances  are 
computed  differently,  and  one  has  no  relation  to  the  other  except  inso- 
far as  both  represent  a  return  of  capital  investment. 

281.— WHAT  THE  LAW  SAYS. 

In  the  language  of  the  law  Deduction  can  be  claimed  for 

(a)  in  the  case  of  oil  and  gas  wells  a  reasonable  allowance  for  ac- 
tual reduction  in  flow  and  production  to  be  ascertained  not  by  the  flush 
flow,  but  by  the  settled  production,  or  regular  flow; 

(b)  in   the    case   of   mines   a   reasonable  allowance  for  depletion 
thereof  not  to  exceed  the  market  value    in    the   mine   of   the   product 
thereof  which  has  been  mined  and  sold  during  the  year  for  which  the 
return  and  computation  are  made, 

such  reasonable  allowance  to  be  made  in  the  case  of  both  (a)  and 


150  THE   INCOME   TAX 

(b)  under  rules  and  regulations  to  be  prescribed  by  the  Secretary  of 
the  Treasury; 

Provided,  That  when  the  allowance  authorized  in  (a)  and  (b) 
shall  equal  the  capital  originally  invested,  or,  in  the  case  of  purchase 
made  prior  to  March  1,  1913,  the  fair  market  value  as  of  that  date,  no 
further  allowance  shall  be  made. 

282.— CAPITAL  TO  BE   RETURNED. 

From  a  careful  reading  of  the  above  quotation  from  the  law  it 
will  appear  that  the  amount  of  capital  to  be  returned  by  allowance  for 
depletion  depends  on  the  date  of  acquisition  of  the  property. 

(a)  If  the  property  was  acquired  prior  to  March  1,  1913,  the  fair 
market  value,  as  of  that  date,  represents  the  capital  eventually  to  be 
returned  by  annual  deductions. 

(b)  If  the  property  has  been  acquired  within  the  period  of  time 
beginning  March  1,  1913,  the  cost  represents  the  capital  eventually  to 
be  returned  by  annual  deductions. 

And  by  "fair  market  value"  and  "cost"  are  meant  the  fair  market 
value  and  cost  of  the  natural  deposits  with  respect  to  the  depletion  of 
which  deduction  is  claimed. 

283.— DEPLETION  OF  OIL  OR  GAS. 

It  has  been  deemed  advisable  here  to  print  in  full  the  regulations 
made  by  the  Treasury  Department  under  date  of  February  8,  1917,  in 
Treasury  Decision  2447,  relative  to  allowances  for  depletion  of  oil  and 
gas.  An  arbitrary  system  of  inserting  subheadings  has  been  intro- 
duced in  order  that  attention  may  be  the  more  readily  directed  to  the 
various  provisions  of  the  decision.  After  quoting  the  law  making  pro- 
vision for  deduction  for  depletion,  the  Department  directs  as  follows : 

Applies  to  Owners. 

The  purpose  of  this  provision  is  to  afford  a  means  whereby  the  in- 
dividual or  corporation  owning  oil  or  gas  producing  properties  may, 
during  the  period  of  operation,  deduct  from  gross  income  the  cost  of, 
or  capital  actually  invested,  in  the  natural  deposits,  if  the  investment 
was  made  subsequent  to  March  1,  1913,  or  the  fair  market  value  as  of 
March  1,  1913,  if  purchased  prior  to  that  date,  the  measure  of  the  de- 
duction being  the  reduction  in  the  flow  and  production. 

Must  Be  Reasonable. 

The  annual  deduction  must  be  reasonable  and  not  in  excess  of 
such  a  percentage  of  the  cost  or  value  as  the  case  may  be  and  as  here- 
in denned,  of  the  oil  or  gas  producing  properties  as  is  indicated  by  the 
reduction  in  the  original  flow  or  settled  production  of  one  year  as  com- 
pared with  that  of  the  preceding  year. 

By  Individual  Well  or  By  Group. 

For  the  purpose  of  this  deduction  note  may  be  taken  of  the  reduc- 
tion in  flow  and  production  of  such  individual  wells  as  were  producing 


THE   INCOME   TAX  151 

oil  or  gas  during  or  at  some  time  within  the  year,  of  groups  of  wells  or 
of  all  wells  in  the  field  or  territory  embraced  in  the  same  ownership. 
If  tested  by  the  aggregate  flow  of  all  of  the  wells  in  the  field  or  terri- 
tory, owned  by  an  individual  or  corporation  and  new  wells  shall  have 
been  developed  during  the  year,  it  is  possible  that  at  the  end  of  the 
year  there  will  have  been  no  reduction  in  flow  and  production,  in  which 
case,  under  the  specific  provision  of  the  law  hereinbefore  quoted  and 
under  which  the  depletion  deduction  is  measured  by  the  reduction  in 
flow  and  production,  there  can  be  no  deduction  for  depletion. 

Hence  in  the  case  of  a  field  or  territory  in  course  of  development 
or  in  which  new  wells  are  being  drilled,  if  the  depletion  deduction  is  to 
be  availed  of  in  the  returns  of  annual  net  income,  each  individual  well 
or  possibly  each  group  of  wells  in  operation  at  the  beginning  of,  or 
brought  in  during  the  year,  if  the  flow  and  production  of  the  group  of 
wells  is  so  assembled  as  to  be  tested,  must  be  tested  at  the  end  of  the 
year  in  order  that  the  decline  in  the  flow  and  production  may  be  de- 
termined. 

New  Wells  or  New  Groups. 

New  wells  or  new  groups  of  wells  brought  in  during  the  year  may 
be  tested  as  soon  as  they  have  reached  the  stage  of  settled  production 
or  regular  flow,  and  then  again  at  the  end  of  the  year.  The  decline  in 
flow  and  production,  if  any,  as  indicated  by  these  tests,  will  be  reduced 
to  a  percentage  basis  and  a  like  percentage  of  the  capital  invested  in 
the  oil  or  gas  property  (exclusive  of  machinery,  equipment,  etc.)  will 
constitute  an  allowable  deduction  from  the  gross  income  of  the  year  on 
account  of  depletion.  Thus  if  the  decline  in  the  flow  and  production 
during  the  year  of,  say,  ten  wells,  costing  $100,000  has  been  5%  as  com- 
pared with  the  production  and  flow  as  indicated  by  a  test  made  at  the 
beginning  of  the  period,  then  5%  of  $100,000  or  $5,000  will,  for  the  year 
for  which  the  computation  is  made,  constitute  an  allowable  depletion 
deduction  in  favor  of  the  individual  or  corporation  owning  and  operat- 
ing the  property. 

When  Wells  Cannot  Be  Grouped. 

If  the  wells  are  not  so  situated  that  their  flow  and  production  may 
be  assembled  in  order  to  test  and  ascertain  the  reduction  in  the  output 
as  a  basis  for  computing  depletion,  it  will  be  necessary  for  the  corpora- 
tion or  individual  owning  the  property  and  claiming  a  depletion  deduc- 
tion, to  take  an  accurate  gauge  of  the  production  and  flow  of  each  well 
at  a  certain  same  period  of  each  year,  and  by  comparing  this  gauge 
with  that  of  the  previous  year,  determine  the  percentage  by  which  the 
production  and  flow  has  been  reduced.  This  having  been  done  as  to 
all  of  the  wells  in  operation,  an  average  percentage  rate  of  reduction 
in  flow  and  production  will  be  ascertained,  and  this  rate  will  be  applied 
to  the  capital  invested,  that  is,  the  value  of  the  oil  or  gas  property  as 
of  March  1,  1913,  or  the  cost  of  the  same,  if  acquired  subsequent  to  that 
date,  for  the  purpose  of  determining  the  amount  which  may  be  allow- 
ably deducted  from  gross  income  by  such  owning  individual  or  corpora- 
tion, on  account  of  depletion. 

In  Fully  Developed  Field. 

In  case  of  a  field  or  territory  fully  developed  and  in  which  no 
new  wells  are  being  drilled,  a  comparison  of  the  quantity  of  oil  or  gas 
produced  during  the  year  for  which  the  computation  is  made  with  the 
quantity  produced  during  the  last  preceding  year,  will  disclose  the  re- 
duction, and  the  percentage  thus  indicated  of  the  reduction  in  flow  and 
production  of  such  field,  will  be  the  measure  of  the  depletion  deduction 
to  be  taken  by  the  owner  with  respect  to  the  capital  invested  in  such 
field. 


152  THE    INCOME   TAX 

Flow  of  Unit  Controls. 

Notwithstanding  the  fact  that  the  drilling  of  new  wells  may  offset 
the  reduction  in  the  production  and  flow  of  the  older  wells  in  the  field 
not  fully  developed,  the  provision  of  the  law  hereinbefore  quoted,  does 
not  authorize,  and  this  office  cannot  permit,  a  depletion  deduction  to 
be  taken  so  long  as  the  flow  and  production  of  the  unit,  be  it  a  well  or 
group  of  wells,  or  the  entire  territory,  is  as  great  during  the  year  for 
which  the  return  is  made  as  it  was  for  the  year  immediately  preceding. 

An  Example  of  Depletion. 

Illustrating  in  a  general  way  the  above  rule  as  applied  to  a  field  or 
territory,  the  case  may  be  taken  of  an  oil  property  in  which  the  capital 
invested,  either  actual  cost  or  fair  market  value  as  the  case  may  be,  is 
$500,000  and  the  production  during  the  year  for  which  the  return  is 
made  was  47,500  barrels,  and  for  the  year  immediately  preceding  50,000 
barrels.  This  would  indicate  a  reduction  in  production  of  2,500  barrels, 
or  a  decline  of  5%.  Applying  this  rate  to  the  capital,  $500,000,  the  indi- 
vidual or  corporation  owning  the  property  would  be  entitled  to  deduct 
from  gross  income  as  depletion  for  the  year  for  which  the  return  is 
made,  the  sum  of  $25,000,  that  is  5%  of  the  invested  capital. 

Percentage  of  Unextinguished  Capital. 

The  depletion  deduction  in  all  cases  until  the  capital  invested  is 
extinguished,  will  be  such  a  percentage  of  the  unextinguished  capital 
as  the  reduction  in  flow  or  production  of  one  year  is  a  percentage  of 
the  flow  or  production  of  the  previous  year. 

Regarding  Fair  Market  Value. 

The  estimate  of  the  fair  market  value  of  gas  and  oil  properties  as 
of  March  1,  1913,  on  which  depletion  deductions  are  based  shall  be  the 
price  at  which  the  property  as  an  entirety  might  have  been  sold  for 
cash  or  its  equivalent  as  of  that  date.  The  value  hereinbefore  contem- 
plated must  naturally  be  determined  by  each  individual  or  corporation 
interested  and  who  is  the  owner  of  the  property,  upon  such  basis  as 
will  not  comprehend  any  operating  profits,  the  estimated  value  in  all 
cases  to  be  subject  to  the  approval  of  the  Commissioner  of  Internal 
Revenue. 

Ledger  Account  Required. 

Every  individual  or  corporation  entitled  to  a  deduction  for  deple- 
tion on  account  of  reduction  in  flow  or  production  of  oil  or  gas  shall 
keep  an  accurate  ledger  account,  in  which  shall  be  charged  the  fair 
market  value  as  of  March  1,  1913,  or  the  cost,  if  the  property  was  ac- 
quired subsequent  to  that  date,  of  the  property  whose  value  declines 
with  the  removal  of  the  natural  deposits.  This  account  shall  be 
credited  with  the  amount  of  the  depletion  deduction  claimed  and 
allowed  each  year,  to  the  end  that  when  the  credits  to  the  account 
equal  the  debits,  no  further  deduction  for  depletion  with  respect  to  this 
propery  and  the  capital  invested  in  it.  will  be  allowed. 

Cannot  Revise  Valuation. 

The  value  determined  and  set  up  as  of  March  1,  1913,  or  the  cost  of 
the  property  if  acquired  subsequent  to  that  date,  will  be  the  basis  for 
determining  the  depletion  deduction  for  all  subsequent  years  during 
the  ownership  under  which  the  value  was  fixed,  and  during  such  owner- 
ship there  can  be  no  revaluation  for  the  purpose  of  this  deduction  if  it 
should  be  found  that  the  estimated  quantity  of  oil  or  gas  contained  in 
the  property  was  under-stated  at  the  time  the  value  was  fixed  or  at  the 
time  the  property  was  acquired. 


THE    INCOME    TAX  153 

The  Lessee's  Rights. 

The  provision  of  the  law  authorizing  the  depletion  deduction,  de- 
signed as  it  is  to  provide  a  means  whereby  the  invested  capital  of  an 
individual  or  corporation  may  not  be  subject  to  the  tax  imposed  by  this 
Title,  does  not  apply  to  individuals  or  corporations  who  are  operating 
oil  or  gas  properties  under  lease,  since  in  those  cases  the  operator  has 
no  capital  invested  in  such  properties.  By  capital  invested,  as  herein 
used,  is  meant  the  fair  market  value  of  the  properties  as  of  March  1, 
1913,  if  acquired  prior  to  that  date,  or  the  actual  cost  if  acquired  sub- 
sequent to  that  date,  as  it  relates  to  the  owner  in  fee  of  the  properties. 

Lessees  will,  however,  be  permitted  to  deduct  from  gross  income 
each  year,  a  reasonable  allowance  for  depreciation,  which  depreciation 
applies  to  the  physical  property  including  rigs,  tools,  machinery  of  all 
kinds,  pipes,  casing,  and  other  equipment  necessary  to  the  operation  of 
the  wells  or  field.  If  lessees,  in  order  to  secure  the  right  to  enter  upon, 
explore,  develop,  or  operate  gas  or  oil  properties,  paid  or  shall  pay,  a 
bonus  in  addition  to  royalties,  the  amount  of  such  bonus  so  paid,  may 
be  ratably  distributed  over  the  life  of  the  lease  or  over  the  productive 
life  of  the  property,  and  the  lessee  may  deduct  annually  as  a  rental 
payment,  an  aliquot  part  of  the  amount  of  the  bonus  so  paid,  until  such 
amount  has  been  extinguished. 

Expense  of  Drilling. 

The  incidental  expenses  of  drilling  wells,  that  is  such  expenses  as 
are  paid  for  wages,  fuel,  repairs,  etc.,  which  do  not  necessarily  enter 
into  and  form  a  part  of  the  capital  invested  or  property  account,  may, 
at  the  option  of  the  individual  or  corporation  owning  and  operating  the 
property,  be  charged  to  property  account  subject  to  depreciation,  or  be 
deducted  from  gross  income  as  an  operating  expense.  If,  in  exercising 
the  option,  the  operating  individual  or  company  charged  the  expense  of 
drilling  wells  to  property  account,  the  same  may  be  taken  into  account 
in  determining  a  reasonable  allowance  for  depreciation  during  each 
year,  until  the  property  account  thus  augumented  has  been  extin- 
guished through  annual  depreciation  deductions,  after  which  no  further 
deduction  on  this  account  will  be  permitted.  The  cost  of  drilling  dry 
or  non-productive  wells  may  be  deducted  from  gross  income  as  a  loss. 

Must  Furnish  Information. 

To  each  return  made  by  an  individual  or  corporation  owning  and 
operating  oil  or  gas  properties,  there  should  be  attached  a  statement 
showing  (1)  (a)  the  fair  market  value  of  the  property  (exclusive  of  ma- 
chinery, equipment,  etc.)  as  of  March  1,  1913,  if  acquired  prior  to  that 
date,  or  (b)  the  actual  cost  of  the  property  if  acquired  subsequent  to 
that  date;  (2)  how  the  fair  market  value  of  the  property  as  of  March  1, 
1913,  was  ascertained;  (3)  the  quantity  of  oil  or  gas  produced  during 
the  year  for  which  the  return  was  made;  (4)  the  quantity  produced 
during  the  year  immediately  preceding;  (5)  how  the  depletion  deduc- 
tion claimed  in  the  return  was  computed,  whether  upon  the  decline  in 
flow  and  production  of  individual  wells,  groups  of  wells,  or  the  entire 
field;  and  (6)  any  other  data  which  would  be  helpful  in  determining  the 
reasonableness  of  the  depletion  deduction  claimed  in  the  return. 

If  the  operator  is  a  lessee,  that  fact  should  be  stated  and  an  ex- 
planation given  as  to  the  basis  and  property  upon  which  any  deprecia- 
tion deduction  is  claimed,  it  being  understood  as  hereinbefore  indicat- 
ed, that  depreciation  relates  to  the  loss  due  to  the  use,  wear  and  tear 
of  physical  property,  and  that  the  lessee  is  not  entitled  to  any  deduc- 
tion for  the  depletion  or  exhaustion  of  the  oil  or  gas  deposits,  but  may 
deduct  annually  as  a  rental  payment,  an  aliquot  part  of  any  bonus  paid 
for  the  right  to  enter  upon,  explore,  develop  and  operate  oil  or  gas  ter- 
ritory as  well  as  the  royalty  payments  made  to  the  lessor  for  the  oil  or 


154  THE    INCOME   TAX 

gas  removed  from  such  property,  provided  the  entire  proceeds  from  the 
oil  or  gas  produced  during  the  year  are  returned  in  the  gross  income  of 
the  operator. 

No  Other  Rule  Applies. 

The  above  rule  for  computing  allowable  depletion  deductions  being 
set  out  in  the  law,  no  deduction  on  this  account  will  be  allowed  if  com- 
puted upon  any  basis  other  than  that  authorized  by  the  law  and  further 
amplified  in  this  decision. 

284.— DEPLETION  OF  MINES. 

Deduction  for  depletion  of  ore  deposits  in  mines  is  calculated 
according  to  an  entirely  different  method — a  method  which  in  certain 
circumstances,  the  Treasury  Department  frankly  admits,  must  be 
based  upon  probable  value.  The  mine  owner,  however,  either  has 
knowledge  of  mining  engineering  himself  or  commands  the  profes- 
sional services  of  engineers ;  hence  the  problem  of  determining  the 
value  and  extent  of  an  ore  deposit  en  bloc  will  not  appear  to  him  as 
perplexing  as  it  does  to  the  layman. 

Again  it  has  been  deemed  advisable  to  quote  the  language  of  the 
Department's  regulations,  based  upon  the  Act  of  September  8,  1916, 
and  issued  in  Treasury  Decision  2446  on  February  7,  1917.  For  the 
convenience  of  the  reader  subheadings  have  been  arbitrarily  inserted. 
The  Department  directs  as  follows : 

Ownership  Essential. 

Ownership  of  the  mine  content  at  the  time  for  which  the  computa- 
tion is  made,  is  an  essential  pre-requisite  to  an  allowable  deduction. 

Distinct  From  Depreciation. 

The  law  authorizes  in  the  case  of  mines,  two  classes  of  deductions 
to  take  care  of  the  wasting  of  assets,  namely,  (a)  depreciation,  (b)  de- 
pletion. . 

Depreciation  comprehends  loss  due  to  exhaustion,  wear  and  tear  of 
physical  property,  other  than  natural  deposits,  and  the  annual  allow- 
ance contemplated  by  this  Title  on  this  account,  will  be  ascertained  by 
spreading  ratably  the  cost  of  the  property  over  the  probable  number  of 
years  constituting  its  life. 

In  determining  the  amount  of  depreciation  deductible  in  the  case 
of  buildings,  the  cost  or  value  of  the  land  upon  which  the  buildings  are 
situated,  will  be  excluded  and  will  not  be  considered  a  part  of  the  ori- 
ginal capital  to  be  extinguished  through  depreciation  deductions.  The 
amount  to  be  taken  care  of  through  depreciation  deductions  applicable 
to  physical  property  other  than  natural  deposits,  will  always  be  the 
capital  invested  in  it,  and  not  a  value  which  may  be  arbitrarily  fixed  as 
of  March  1,  1913,  or  as  of  any  other  date. 

Must  Get  Value  En  Bloc. 

In  case  of  mines  (other  than  oil  and  gas  wells),  if  the  property  was 
acquired  prior  to  March  1,  1913,  the  amount  of  invested  capital  which 
may  be  extinguished  through  annual  depletion  deductions  from  gross 
income,  will  be  the  fair  market  value  of  the  mine  property  as  of  March 


THE    INCOME   TAX  155 

1,  1913.  The  value  contemplated  herein  as  the  basis  for  depletion  de- 
ductions, authorized  by  this  Title,  must  not  be  based  upon  the  assumed 
salable  value  of  the  output  under  current  operative  conditions  less  cost 
of  production,  for  the  reason  that  the  value  under  such  conditions 
would  comprehend  the  earning  capacity  of  the  property. 

Neither  must  the  value  determined  as  of  March  1,  1913,  be  specula- 
tive, but  must  be  determined  upon  the  basis  of  the  salable  value  en  bloc 
as  of  that  date,  of  the  entire  deposit  of  minerals  contained  in  the  prop- 
erty owned,  exclusive  of  the  improvements  and  development  work; 
that  is,  the  price  at  which  tha  natural  deposits  or  mineral  property  as 
an  entirety  in  its  then  condition,  could  have  been  disposed  of  for  cash 
or  its  equivalent. 

Depletion  Measured  By  Unit. 

The  value  en  bloc  having  been  thus  ascertained,  an  estimate  of  the 
number  of  units  (tons,  pounds,  etc.)  should  be  made.  The  en  bloc 
value  divided  by  the  estimated  number  of  units  in  the  mine  or  mining 
property  will  determine  the  per  unit  value,  which,  multiplied  by  the 
number  of  units  mined  and  sold  during  any  one  year,  will  determine 
the  sum  which  will  constitute  an  allowable  deduction  from  the  gross 
income  of  that  year  on  account  of  depletion. 

Deductions  computed  on  a  like  basis  may  be  made  from  year  to 
year  during  the  ownership  under  which  the  value  was  determined,  until 
the  aggregate  en  bloc  value  as  of  March  1,  1913,  of  the  mine  or  mineral 
deposits  shall  have  been  extinguished,  after  which  no  further  deduc- 
tion on  account  of  depletion  with  respect  to  this  property,  will  be 
allowed  to  the  individual  or  corporation  under  whose  ownership  the  en 
bloc  value  was  determined. 

The  precise  detailed  manner  in  which  the  estimated  fair  market 
value  of  mineral  deposits  as  of  March  1,  1913,  shall  be  made  must 
naturally  be  determined  by  each  individual  or  corporation  interested, 
and  who  is  the  owner  thereof,  upon  such  basis  as  must  not  comprehend 
any  operating  profits,  the  estimate  in  all  cases  to  be  subject  to  the  ap- 
proval of  the  Commissioner  of  Internal  Revenue. 

Ledger  Account  Required. 

Every  individual  or  corporation  claiming  and  making  a  deduction 
for  depletion  of  natural  deposits  shall  keep  an  accurate  ledger  account, 
in  which  shall  be  charged  the  fair  market  value  as  of  March  1,  1913,  or 
the  cost,  if  the  property  was  acquired  subsequent  to  that  date,  of  the 
mineral  deposits  involved.  This  account  shall  be  credited  with  the 
amount  of  the  depletion  deduction  claimed  and  allowed  each  year,  to 
the  end  that  when  the  credits  to  the  account  equal  the  debits,  no  fur- 
ther deduction  for  depletion  with  respect  to  this  property  will  be 
allowed. 

Cannot  Revise  Valuation. 

The  value  determined  and  set  up  as  of  March  1,  1913,  or  the  cost  of 
the  property  if  acquired  subsequent  to  that  date,  will  be  the  basis  for 
determining  the  depletion  deduction  for  all  subsequent  years  during  the 
ownership  under  which  the  value  was  fixed,  and  during  such  owner- 
ship, there  can  be  no  re-valuation  for  the  purpose  of  this  deduction,  if 
it  should  be  found  that  the  estimated  quantity  of  the  mineral  deposit 
was  understated  at  the  time  the  value  was  fixed  or  at  the  time  the 
property  was  acquired. 

When  Data  Is  Lacking. 

In  cases  wherein  the  quantity  of  the  mineral  deposit  in  the  mine 
prior  to  March  1,  1913,  cannot  be  estimated  with  any  degree  of  accu- 
racy, it  will  be  necessary,  if  depletion  deductions  are  to  be  availed  of, 


156  THE    INCOME   TAX 

for  the  individual  or  corporation  owning  the  deposits,  with  the  best  in- 
formation available,  to  arrive  at  the  fair  market  value  of  the  property 
as  of  March  1,  1913,  that  is,  its  fair  cash  value  en  bloc  if  such  value  is 
believed  to  be  other  than  its  original  cost,  which  value,  during  the 
period  of  the  ownership  under  which  it  was  determined,  shall  be  final, 
and  shall  be  charged  to  the  property  account  as  hereinbefore  indicated, 
and  then,  on  the  basis  of  the  most  probable  number  of  units  in  the 
property,  the  per  unit  value  shall  be  determined  as  the  basis  for  com- 
puting annual  depletion  allowances,  this  method  and  allowances  to  be 
continued  until,  but  not  beyond,  the  time  when  the  value  as  of  March  1. 
1913,  shall  have  been  extinguished. 

The  original  cost  of  the  mineral  deposit  may  be  taken  as  the  basis 
for  computing  annual  depletion  deductions  if  the  fair  market  value  as 
of  March  1,  1913,  as  hereinbefore  required,  cannot  be  ascertained  other- 
wise, allowance  being  made  for  minerals  which  may  have  been  re- 
moved prior  to  that  date. 

Acquired  on  or  After  March  1,  1913. 

In  cases  wherein  a  mine  or  mineral  property  was  acquired  subse- 
quent to  March  1,  1913,  the  same  rule  for  computing  the  annual  deple- 
tion deduction  will  apply  except  that  in  such  case  the  basis  of  the  com- 
putation will  be  the  actual  cost  rather  than  the  value  as  of  March  1, 
1913. 

The  Lessee's  Rights. 

The  foregoing  rules  apply  to  owners  in  fee  of  mines  and  mining 
properties  and  do  not  contemplate  that  an  individual  or  corporation 
operating  a  mine  under  lease  on  a  royalty  basis,  shall  be  entitled  to  any 
deduction  for  depletion.  If,  however,  the  lessee,  in  addition  to  royal- 
ties, paid  or  pays  a  stipulated  sum  for  the  right  to  explore,  develop  and 
operate  a  mine,  the  amount  so  paid  may  be  ratably  distributed  over  the 
life  of  the  lease  or  the  probable  life  of  the  mine  under  ordinary  operat- 
ing conditions,  and  the  lessee  may  deduct  annually  as  a  rental  pay- 
ment, an  aliquot  part  of  the  amount  of  the  bonus  so  paid,  until  such 
amount  has  been  extinguished. 

Must  Furnish  Information. 

To  the  return  made  pursuant  to  the  above  rule,  there  should  be  at- 
tached a  statement  setting  out  (1)  whether  the  operator  is  a  fee  owner 
or  lessee;  (2)  in  the  case  of  a  fee  owner,  (a)  the  fair  market  value  of 
the  mineral  deposits  as  of  March  1,  1913,  if  the  property  was  acquired 
prior  to  that  date,  (b)  the  cost  of  the  mineral  property  if  acquired  sub- 
sequent to  that  date;  (3)  the  method  by  which  the  value  as  of  March  1, 
1913,  was  determined  in  case  the  property  was  acquired  prior  to  that 
date;  (4)  the  estimated  quantity  in  units  in  the  mine  as  of  March  1. 
1913,  or  at  the  date  of  purchase  if  acquired  subsequent  to  that  date; 
(5)  the  number  of  units  removed  and  sold  during  the  year  for  which 
the  return  was  made;  and  (6)  any  other  data  which  would  be  helpful  in 
determining  the  reasonableness  of  the  depletion  deduction  claimed  in 
the  return. 

In  the  case  of  a  lessee,  the  statement  should  show  (a)  the  amount 
of  the  bonus  or  other  payment  made  for  the  right  to  operate  the  mine; 
(b)  the  period  covered  by  the  lease. 

285.— WHEN   PROBABILITIES   CONTROL. 

Referring  to  the  fourth  paragraph  back  under  the  heading 
"When  Data  Is  Lacking,"  it  can  only  be  suggested  here  that  the  mine 
owner  make  a  conscientious  effort  to  comply  with  the  spirit  of  the 


THE    INCOME   TAX  157 

law  and  submit  the  case  with  an  explanation  to  the  Treasury  Depart- 
ment for  its  judgment.  In  such  circumstances,  frankness  on  the  part 
of  the  mine  owner  will  contribute  materially  to  the  solution  of  the 
problem. 


158  THE    INCOME    TAX 


CHAPTER  XIX 


THE  INCOME  TAX 


FILING  OF  CORPORATION  RETURN. 


286.— PERIOD  COVERED. 

A  corporation  can  base  its  return  upon  either  the  calendar  year 
or  its  own  fiscal  year.  This  is  a  privilege  not  extended  individuals. 

Except  in  the  case  of  new  corporations,  or  corporations  that  go 
out  of  business  and  dissolve,  or  corporations  changing  from  the  calen- 
dar-year to  the  fiscal-year  basis,  a  return  must  be  for  a  twelve- 
months' period.  And,  except  in  the  case  of  a  corporation  dissolving 
and  closing  its  affairs  by  filing  a  final  return,  a  return  must  be  for  a 
period  closing  with  the  last  day  of  some  month — the  last  day  of  De- 
cember if  filed  for  the  calendar  year,  or  the  last  day  of  some  other 
month  if  filed  for  a  fiscal  year  differing  from  the  calendar  year. 

It  is  immaterial  to  the  Government  whether  a  corporation  file  re- 
turn for  the  calendar  or  its  own  fiscal  year.  But  if  return  is  to  be 
filed  for  its  own  fiscal  year,  a  corporation  must  comply  with  certain 
specific  requirements. 

287.— FISCAL-YEAR  RETURN. 

A  Collector  of  Internal  Revenue  is  not  allowed  to  accept  a  return 
made  for  a  fiscal  year  unless  the  corporation  offering  it  has  followed 
precisely  the  rules  laid  down  for  establishing  the  right  so  to  file  in- 
stead of  on  the  basis  of  the  calendar  year.  As  simply  as  possible  these 
rules  will  be  explained. 

The  corporation  must  give  notice  in  writing  to  the  Collector  of 
Internal  Revenue  of  its  desire  to  file  upon  the  basis  of  a  fiscal  year 
and  in  such  notice  must  designate  the  last  day  of  some  month  as  the 
close  of  its  fiscal  year. 


THE    INCOME   TAX  159 

This  notice  must  be  in  the  hands  of  the  Collector  not  less  than 
thirty  days  prior  to  March  1,  of  the  year  in  which  the  desired  fiscal 
year  period  of  twelve  months  closes. 

The  notice  having  been  given,  as  just  explained,  the  corporation 
will,  on  or  before  March  1,  file  a  return  for  that  portion  of  the  pre- 
ceding calendar  year  that  elapsed  before  the  beginning  of  the  fiscal 
year  period  of  twelve  months  on  which  it  is  desired  hereafter  to  file 
return.  This  is  to  clear  up  the  business  of  the  corporation  with  the 
Government  to  the  beginning  of  its  fiscal  year. 

Next,  having  filed  return  for  the  portion  of  the  preceding  calen- 
dar year  that  elapsed  before  the  beginning  of  its  fiscal  year,  the  cor- 
poration will  wait  until  its  fiscal  year  closes,  as  designated  in  the 
notice  to  the  Collector,  and  thereafter  will,  within  sixty  days  of  the 
close  of  such  fiscal  year,  file  a  return  for  the  full  fiscal  year  period. 

The  above  will  not  appear  so  complicated  if  studied  according  to 
the  following  illustrations : 

A  corporation,  which  filed  its  return  for  the  calendar  year  1916, 
desires  to  change  to  a  fiscal-year  basis  and,  therefore,  not  file  for  the 
calendar  year  ending  December  31,  1917.  It  desires  to  designate  a  fis- 
cal year  which,  when  first  put  into  effect,  will  begin  in  the  year  1917, 
but  an  end  in  the  year  1918 — suppose  the  proposed  fiscal  year  be  to 
end  with  the  last  day  of  August.  The  corporation  cannot,  however, 
under  the  law,  cover  more  than  twelve  months  in  one  return.  It  must 
proceed  as  follws:  (1)  Not  less  than  thirty  days  prior  to  March  1, 
1918,  file  with  the  Collector  a  written  notice  designating  the  last  day  of 
August  as  the  close  of  its  fiscal  year  and  stating  that  return  will  be 
filed  according  to  such  fiscal  year;  (2)  on  or  before  March  1,  1918, 
file  with  the  Collector  a  return  of  income  for  that  part  of  the  year 

1917  beginning  January    1    and  ending  August  31;   (3)  within  sixty 
days  after  August  31, 1918  file  a  return  of  income  for  its  fiscal  year  be- 
ginning September  1,  1917   and   ending  August  31,  1918;   (4)  there- 
after, file  each  year  for  its  full  fiscal  year  within  sixty  days  after  the 
last  day  of  August. 

To  the  case  of  a  corporation  organized  during  the  year  1917  and 
desirous  of  establishing  a  fiscal-year  basis  the  example  just  given  is 
readily  adaptable. 

Suppose  the  corporation  was  organized  April  10,  1917  and  did  not, 
therefore,  file  a  return  for  the  calendar  year  1916.  It  has  no  status  in 
the  Collector's  office,  except  that  information  as  to  its  organization 
has  reached  him  and  a  return  will  be  expected  on  or  before  March  1, 

1918  for  that  part  of  the  calendar  year   1917   beginning  April  10  and 


160  THE   INCOME   TAX 

ending  December  31,  unless  the  corporation  itself  take  the  initiative 
in  establishing  a  fiscal-year  basis.  In  such  a  case,  should  it  desire  a 
fiscal  year  ending  with  the  last  day  of  August,  the  new  corporation 
would  take  the  following  course:  (1)  Not  less  than  thirty  days  prior 
to  March  1,  1918  file  with  the  Collector  a  written  notice  designating 
the  last  day  of  August  as  the  close  of  its  fiscal  year  and  stating  that 
return  will  be  filed  according  to  such  fiscal  year;  (2)  on  or  before 
March  1,  1918  file  with  the  Collector  a  return  of  income  for  that  part 
of  the  year  1917  beginning  April  10  and  ending  August  31;  (3)  with- 
in sixty  days  after  August  31,  1918  file  a  return  of  income  for  its  full 
fiscal  year  beginning  September  1,  1917  and  ending  August  31,  1918; 
(4)  thereafter  file  each  year  for  its  full  fiscal  year  within  sixty  days 
after  the  last  day  of  August. 

Unless  the  foregoing  instructions  are  followed  a  fiscal-year  re- 
turn will  not  be  accepted. 

The  examples  given  show  that  a  corporation  may  either  begin  its 
income-tax  relations  with  the  Government  according  to  the  fiscal- 
year  method  of  filing  return,  or  that  it  may  change  from  a  calendar- 
year  to  fiscal-year  basis  after  having  filed  according  to  the  calendar 
year. 

It  is  essential  that  the  last  day  of  some  month  be  designated  as 
the  close  of  a  fiscal  year.  The  Government  will  not  recognize  a  fiscal 
year  closing  on  any  but  the  last  day  of  a  month. 

288.— WHEN  TO  BE  FILED. 

A  return  for  the  calendar  year  must  be  filed  on  or  before  the  first 
day  of  March  of  the  following  year — that  is  a  return  for  the  calendar 
year  1917  must  be  filed  on  or  before  March  1,  1918,  and  so  on.  The 
first  day  of  March  is  the  last  day  of  the  filing  period. 

A  return  for  a  corporation's  fiscal  year  must  be  filed  within  sixty 
days  after  the  close  of  such  fiscal  year.  The  sixtieth  day  after  the 
close  of  the  fiscal  year  is  the  last  day  of  the  filing  period  in  such  a 
case.  [See  instructions  regarding  "Fiscal  Year  Return."] 

When  the  last  day  of  the  filing  period  falls  on  a  Sunday  or  legal 
holiday,  the  last  due  date  is  the  day  following  the  Sunday  or  legal 
holiday. 

289.— HOW  FILED. 

The  filing  of  a  return  means  the  delivery  of  the  return  to  the  Col- 
lector of  Internal  Revenue.  This  must  be  accomplished  by  a  corpora- 
tion on  or  before  the  first  day  of  March,  in  the  case  of  a  calendar-year 


THE  INCOME  TAX  161 

return,  or  within  sixty  days  after  the  close  of  its  fiscal  year,  in  the 
case  of  a  fiscal-year  return.  [Also  see  paragraph  "How  Filed"  in  in- 
st  uctions  given  individuals.] 

A  corporation's  return  should  be  signed  and  verified  by  two  offi- 
cers of  the  corporation — preferably  by  the  President  and  Treasurer — 
but  the  signatures  of  such  other  responsible  officers  as  the  Vice-presi- 
dent and  Secretary  will  be  accepted  if  the  President  and  Treasurer's 
signatures  are  not  available.  In  some  circumstances  returns  have 
been  accepted  with  the  signature  of  only  one  officer  but  this  has 
not  been  strictly  according  to  law.  The  return  must  also,  and  in 
every  instance,  be  sworn  to  before  an  officer  authorized  to  administer 
oaths.  It  can  be  sworn  to  before  the  Collector  of  Internal  Revenue 
or  one  of  his  deputies. 

290.— WHERE   FILED. 

A  domestic  corporation  is  required  to  file  its  return  with  the  Col- 
lector of  Internal  Revenue  of  the  district  in  which  its  principal  office 
is  located,  and  by  "principal  office"  is  meant  the  place  where  are  kept 
its  books  of  account.  However,  if  the  books  of  account  of  a  domestic 
corporation  are  kept  in  a  foreign  country  the  return  should  be  made 
in  the  district  where  it  has  its  principal  branch  office  in  the  United 
States. 

A  foreign  corporation  is  required  to  file  its  return  in  the  district 
where  is  located  its  principal  place  of  business  in  the  United  States. 
If  it  has  no  such  place  of  business,  then  it  must  file  with  the 
Collector  of  Internal  Revenue  at  Baltimore,  Md.  (the  district  which 
includes  the  District  of  Columbia).  If  a  foreign  corporation  has  sev- 
eral branch  offices  in  the  United  States,  it  should  designate  one  of 
them  as  its  principal  place  of  business  in  this  country. 

29L— RECEIPT  FOR  RETURN. 

Each  corporation  is  entitled  to  a  receipt  from  the  Collector  when 
it  files  its  return  and  should  ask  for  this  evidence  of  filing  as  a  protec- 
tion against  subsequent  possible  loss  of  the  return.  The  Department 
has  provided  a  form  on  which  the  receipt  can  be  issued. 

292.— FORM   TO  BE  USED. 

A  corporation's  return  must  be  made  on  one  of  several  prescribed 
forms  to  be  obtained  from  the  Collector  of  Internal  Revenue  by  writ- 
ten or  personal  request.  Certain  corporations  must  use  special 
forms  :  therefore,  state  in  asking  for  a  form  in  which  of  the  following 
classes  the  corporation  belongs  : 

(a)   Corporations    in    general,  other  than  insurance  and 

steam-railroad  corporations. 


162  THE    INCOME   TAX 

(b)  Insurance  corporations,  including    mutual    life    and 
mutual  marine  insurance  corporations. 

(c)  Mutual   Insurance   corporations   other   than   mutual 
life  and  mutual  marine  insurance  corporations. 

(d)  Steam-railroad  corporations. 

293.— KEEP  COPY  OF  RETURN. 

And,  as  in  the  case  of  individuals,  it  is  suggested  that  each  cor- 
poration keep  a  copy  of  its  return.  Two  copies  of  the  return  form 
should  be  requested  so  that  the  retained  copy  may  be  on  the  official 
form.  If  the  extra  copy  of  the  official  form  cannot  be  obtained  the 
copy  of  the  return  retained  should  be  made  on  an  improvised  form. 

294.— EXTENSION  OF  TIME. 

An  extension  of  time  not  to  exceed  thirty  days  from  the  time 
prescribed  by  law  in  which  to  file  a  return  can  be  granted  by  a  Col- 
lector of  Internal  Revenue  when  such  extension  is  necessary  because 
of  the  sickness  or  absence  of  an  officer  of  the  corporation  who  is  re- 
quired to  verify  its  return.  These  reasons  are  the  only  ones  that  can 
be  considered  by'  the  Collector. 

An  extension  for  more  than  thirty  days  can  be  granted  by  the 
Commissioner  of  Internal  Revenue ;  in  fact,  the  Commissioner  can 
grant  his  extension  for  any  reasonable  time  in  any  meritorious  case. 

IJF  a  30-day  extension  is  desired  written  application  must  be  made 
for  it  to  the  Collector  prior  to  the  expiration  of  the  period  for  which 
the  extension  is  requested,  and  in  this  application  the  necessity  for 
having  the  time  for  filing  extended  must  be  explained.  This  applica- 
tion does  not  have  to  be  made  on  or  before  March  1.  It  can  be  made 
within  the  thirty  days  following  March  1  (or  within  the  thirty  days 
after  the  end  of  the  sixty-day  period  following  the  close  of  a  fiscal 
year)  ;  in  such  case,  however,  the  corporation  officers  should  be  sure 
that  their  reasons  are  adequate.  If  they  are  in  doubt,  the  application 
for  extension  should  be  made  in  sufficient  time  to  allow  them  to  file 
the  corporation's  return  on  or  before  March  1,  (or  within  sixty  days 
after  the  close  of  the  fiscal  year)  in  the  event  of  the  refusal  to  grant 
the  request  for  extension. 

When  an  extension  for  more  than  thirty  days  is  desired,  the  ap- 
plication should  be  made  and  facts  stated  in  a  letter  to  the  Collector, 
who  will  transmit  the  request  to  the  Commissioner  at  Washington  for 
action.  Time  should,  therefore,  be  allowed  for  reference  to  Washing- 
ton. 


THE    INCOME   TAX  163 

When  a  return  is  tiled  at  an  extended  date,  the  fact  that  the  time 
has  been  extended  should  be  noted  on  the  margin,  or  by  a  rider 
attached. 

The  Commissioner  at  Washington  has  been  liberal  and  consider- 
ate in  extending  the  time  in  the  case  of  non-resident  alien  individuals 
and  corporations,  and  in  the  case  of  American  citizens  traveling 
abroad. 

295.— TENTATIVE   RETURN. 

If  circumstances  make  it  impossible  to  file  a  complete  return 
within  the  time  prescribed  by  law,  and  if  an  extension  of  time  has  not 
been  obtained,  a  corporation  may  file  a  tentative  or  partial  return,  and 

later  substitute  for  it  a  complete  return  when  it  has  been  possible  to 
assemble  the  necessary  data.  It  is  not  necessary,  however,  for  a  cor- 
poration to  avail  itself  of  this  privilege  for  when  its  case  is  meritori- 
ous (even  though  its  reasons  are  not  the  sickness  or  absence  of  one 
of  its  officers)  it  can  obtain  an  extension  for  any  reasonable  time  from 
the  Commissioner. 

296.— SUPPLEMENTARY  STATEMENT. 

The  Supplementary  Statement  is  a  part  of  a  corporation's  return 
of  income  and  the  demand  for  it  has  the  backing  of  the  law  the  same 
as  has  the  return  proper.  Either  the  filling  out  of  this  statement  or 
the  substitution  of  another  that  wrill  explain  in  as  full  detail  how  the 
corporation  has  arrived  at  its  gross  income  and  deductions  is  neces- 
sary. The  Department  prefers  the  use  of  the  Supplementary  State- 
ment for  which, provision  has  been  made  on  the  official  return  form, 
but  has  not  been  unyielding  in  this  respect.  Collectors  have  been  in- 
structed, however,  not  to  accept  a  return  unless  it  is  accompanied  by 
some  detailed  Supplementary  Statement  giving  all  the  information 
essential  to  the  proper  auditing  of  the  return. 

The  Supplementary  Statements  of  insurance  companies  must 
give  data  essential  to  the  enforcement  of  the  provisions  of  the  law 
peculiarly  applicable  to  such  corporations.  The  requirements  of  the 
Department  in  this  respect  are  as  follows : 

A.11  insurance  companies  should  include  and  attach  to  their  returns 
a  supplementary  statement  showing,  for  life  companies,  the  aggregate 
of  items  "of  such  portion  of  any  actual  premium  received  from  any  in- 
dividual policyholder  as  shall  have  been  paid  back  or  credited  to  such 
individual  policyholder,  or  treated  as  an  abatement  of  premium  of  such 
individual  policyholder  within  such  year;"  in  the  case  of  mutual  fire 
insurance  companies  a  statement  showing  "any  portion  of  the  premium 
deposits  returned  to  their  policyholders ; "  and  in  the  case  of  mutual 
marine  companies  "amounts  repaid  to  policyholders  on  account  of  pre- 
miums previously  paid  by  them,  and  interest  paid  upon  such  amounts 
between  the  ascertainment  thereof  and  the  payment  thereof,"  which 
are,  or  may  be,  omitted  from  gross  income. 


164  THE    INCOME   TAX 

297.— INFORMATION  AS  TO  EXEMPT  INCOME. 

The  Supplementary  Statement,  while  a  part  of  the  return  of  in-- 
come, is  not  the  basis  of  assessment  of  tax.  It  is  essentially  a  state- 
ment of  information.  In  it  will  be  found  a  space  requiring  that  hold- 
ing's of  United  States,  State  and  municipal  bonds  be  listed.  This  re- 
quirement should  be  complied  with  although  the  income  from  such 
bonds  does  not  enter  into  the  computation  of  tax  liability. 

298.— WHEN  NO  RETURN  IS  FILED. 

If  a  corporation's  return  is  not  received  within  the  time  pre- 
sc  ibed  by  law,  or  within  the  period  covered  by  an  extension  of  time, 
the  Collector  issues  a  notice  of  delinquency  in  filing  and  demand  for  a 
return.  If  a  return  is  not  filed  within  ten  days  from  the  date  of  this 
notice,  it  becomes  the  duty  of  the  Collector  to  examine  the  books  of 
the  corporation  and  prepare  a  return,  which  can  be  taken  as  a  legal 
basis  of  assessment,  even  without  the  signatures  of  officers  of  the 
corporation.  It  therefore,  behooves  a  corporation  to  give  immediate 
attention  to  such  a  notice,  for  the  Collector  has  full  authority  of  law 
to  back  it  up  with  action. 

Similar  action  can  be  taken  by  the  Collector  with  respect  to  indi- 
viduals who  fail  to  file  their  returns  according  to  law. 

299.— CORRECTION  OF  A  RETURN. 

In  this  respect  a  corporation  has  the  same  rights  as  an  individual. 
It  is  therefore  suggested  that  the  similar  paragraph  in  instructions 
given  individuals  be  consulted. 

300.— PENALTY  FOR  NEGLECT  TO  FILE. 

Punishment  for  neglect  or  refusal  to  file  a  return  of  income  with- 
in the  time  prescribed  by  law,  or  covered  by  an  extension,  takes  two 
forms — one  a  specific  penalty  of  not  to  exceed  $10,000,  and  the  other 
an  increase  of  the  amount  of  tax  found  to  be  due  by  50  per  cent. 

301.— PENALTY  FOR  FALSE  RETURN. 

In  the  case  of  the  filing  of  a  false  return  the  specific  penalty 
would  remain  the  same,  but  the  increase  of  tax  found  to  be  due  would 
be  to  the  extent  of  100  per  cent.  Moreover,  with  respect  to  a  false  re- 
turn, the  officers  of  the  corporation  signing  it  could  be  prosecuted  for 
perjury,  or  could  be  prosecuted  under  the  amendment  carried  by  the 
War  Revenue  Act,  providing  a  fine  not  exceeding  $2,000,  a  year  in 
prison,  or  both. 


THE   INCOME   TAX  165 

302.— ON  BASIS  OTHER  THAN  RECEIPTS. 

Ordinarily  a  corporation's  return  is  to  be  based  upon  income  re- 
ceived and  deductions  actually  paid  out  during  the  year  for  which  it  is 
made.  However,  the  law  provides  that  a  corporation  keeping  ac- 
counts upon  any  basis  other  than  that  of  actual  receipts  and  disburse- 
ments may  make  its  return  upon  the  basis  upon  which  its  accounts  are 
kept,  provided  such  basis  clearly  reflects  its  income  and  comes  within 
regulations  prescribed  by  the  Commissioner  of  Internal  Revenue. 

The  same  provision  is  carried  in  the  law  with  respect  to  the  re- 
turn of  an  individual  whose  system  of  accounting  is  not  strictly  ac- 
cording to  actual  receipts  and  disbursements. 

[See  paragraph  on  this  subject  in  chapter  on  "Miscellaneous  Pro- 
visions, Income  Tax."] 


166  THE    INCOME   TAX 


CHAPTER  XX 


THE  INCOME  TAX 


MISCELLANEOUS  PROVISIONS 
INCOME  TAX 


In  this  chapter  special  attention  is  given  certain  subjects  which 
may  be  covered  in  other  chapters.  The  reason  for  repetition  and  ex- 
planation in  greater  detail  with  respect  to  certain  questions  and 
problems  that  must  arise  is  based  upon  an  experience  which  has  shown 
that  they  require  emphasis. 

303.— FIXING  LIABILITY   OF   HUSBAND 
AND  WIFE  TO  MAKE  RETURN. 

The  law  provides  that  only  one  specific  exemption  shall  be  claimed 
by  husband  and  wife  living  together.  This  may  be  claimed  in  a  joint 
return,  or  in  whole  by  one  in  the  case  of  separate  returns,  or  may  be 
divided  between  the  two  in  the  case  of  separate  returns. 

When  husband  and  wife  are  living  together  and  have  separate 
estates  they  may  make  a  joint  return,  but  in  such  return  the  income 
of  each  must  be  separately  stated  and  the  names  of  both  must  be 
given.  If  a  joint  return  is  made  it  need  be  signed  only  by  the  husband. 

If  a  wife,  living  with  her  husband,  makes  a  separate  return,  her 
return  should  be  attached  to  that  filed  by  her  husband. 

If  either  husband  or  wife  separately  has  a  net  income  equal  to  or 
in  excess  of  the  specific  exemption  [under  the  Act  of  October  3,  1917, 
(War  Income  Tax),  $2,000,]  a  return  must  be  filed  and  such  return 
must  include  the  income  of  both. 

If  the  aggregate  net  income  of  both  exceeds  the  specific  exemp- 
tion (as  stated  in  brackets  in  the  preceding  paragraph),  a  return  of 
their  combined  incomes  must  be  filed,  although  neither  one  separately 
may  have  a  net  income  equal  to  the  specific  exemption. 


THE    INCOME   TAX  167 

If  either  a  husband  or  a  wife  has  separate  income,  or  if  both  have 
separate  incomes,  sufficient  in  amount,  considered  separately,  to  be 
subject  to  the  additional  tax,  it  is  suggested  that  they  make  separate 
returns.  For,  while  the  normal  tax  is  levied  upon  combined  income, 
the  additional  tax  is  assessed  upon  the  income  of  each,  alone. 

In  the  case  of  the  death  of  either  husband  or  wife  during  the  year, 

if  the  deceased  had  a  net  income  for  that  part  of  the  year  prior  to 
death  equal  to  the  amount  of  the  specific  exemption,  a  return  of  in- 
come must  be  made  by  the  administrator  or  executor  for  the  period 
beginning  with  January  1  and  ending  with  the  date  of  death,  and  in 
such  return  the  administrator  or  executor  can  claim  for  the  deceased 
a  full  year's  exemption.  The  survivor  (widow  or  widower)  would, 
then,  at  the  end  of  the  calendar  year  have  the  status  of  a  single 
person  and  would  have  to  make  separate  return  and  be  allowed 
specific  exemption  accordingly,  unless  the  survivor  be  able  to 
Qualify  as  "head  of  a  family,"  or  have  been  married  again  prior  to 
the  end  of  the  year  on  December  31.  [Under  the  Act  of  October  3, 
1917  (War  Income  Tax)  every  single  person,  citizen  or  resident  of  the 
United  States,  who  is  not  the  head  of  a  family,  is  allowed  a  specific 
exemption  of  $1,000,  and  must  make  return  if  in  receipt  of  net  income 
of  that  amount  or  more.] 

304.— TAX-FREE  GUARANTY  IN 
CORPORATION  BONDS. 

The  holder  of  corporation  bonds  containing  a  clause  to  the  effect 
that  the  interest  shall  be  paid  without  deduction  for  any  tax  that  may 
be  assessed,  must  not  conclude  that  by  such  clause  income-tax  lia- 
bility with  respect  to  the  interest  is  transferred  to  the  corporation 
which  has  issued  the  bonds.  On  the  contrary  income-tax  liability  re- 
mains with  the  holder  of  the  bonds.  To  the  holder  of  the  bonds  this 
interest  is  income,  the  same  as  any  other  kind  of  interest  or  other 
form  of  gain.  The  Treasury  Department  holds  that  the  guaranty 
clause  in  the  bond  is  a  contract  wholly  between  the  corporation  and 
the  bondholder.  The  interest  received  on  such  bonds  must  be  ac- 
counted for  by  the  bondholders  in  their  returns,  either  as  income 
which  has  been  taxed  at  the  source  or  as  income  which  has  not  been 
taxed  at  the  source,  according  to  the  form  of  ownership  certificate 
used  in  presenting  the  interest  coupons  for  payment.  Such  income 
is  not  always  taxed  at  the  source.  (See  particularly  and  read  care- 
fully instructions  on  this  point  in  chapter  on  "Deduction  of  Tax  and 
Information  at  the  Source." 


168  THE    INCOME   TAX 

If  a  domestic  corporation  owns  such  bonds,  its  income  not  being 
subject  to  tax  at  the  source  under  the  law,  it  must  include  the  amount 
of  such  interest  in  full  in  its  return,  regardless  of  the  guaranty  in  the 
bonds.  It  must  pay  the  tax  due  on  its  total  net  income,  including  such 
interest,  and  can  look  for  reimbursement  only  to  the  corporation 
which  has  issued  the  bonds. 

305.— SPECIFIC  EXEMPTION   NOT  ALLOWABLE 
FOR  ADDITIONAL  TAX . 

The  specific  exemption  is  not  allowable  as  a  credit  against  net  in- 
come in  the  computation  of  the  additional  tax.  It  applies  only  to  th? 
computation  of  the  normal  tax. 

306.— DIVIDENDS  NOT  A  CREDIT 
FOR  ADDITIONAL  TAX. 

That  part  of  an  individual's  income  received  in  the  form  of  divi- 
dends on  the  stock  of  corporations  subject  to  tax,  while  deductible 
from  net  income  as  a  credit  in  the  computation  of  the  normal  tax,  is 
not  allowable  as  a  credit  in  the  computation  of  the  additional  tax. 

307.— INCOME  TAXED   AT  SOURCE   NOT 
A  CREDIT  FOR  ADDITIONAL  TAX. 

That  part  of  an  individual's  income,  if  any,  on  which  the  normal 
tax  has  been  deducted  and  withheld  at  the  source,  enters  into  the  com- 
putation of  the  normal  tax  due  directly  from  the  individual,  as  a 
credit  according  to  the  amount  of  the  deduction  at  the  source.  How- 
ever, as  no  more  than  a  normal  tax  can  be  deducted  at  the  source  in 
any  circumstances,  the  income  subjected  to  such  deduction  does  not 
offer  a  credit  in  the  computation  of  the  additional  tax. 

308.— WHEN  EARNINGS  OF  CORPORATION  ARE 
HELD  TO  EVADE  TAX. 

The  Act  of  September  8,  1916  provides  against  the  accumulation 
of  the  earnings  of  a  corporation  without  declaration  of  dividends  in 
order  that  the  individual  stockholders  may  not  have  to  include  the 
amount  of  dividend  payments  in  their  respective  returns.  The  taxable 
income  of  the  individuals  can  be  increased  for  the  assessment  of  the 
additional  tax  by  the  shares  of  the  corporation's  earnings  to  which 
they  are  entitled,  whether  the  earnings  have  been  distributed  or  not, 
when  it  can  be  shown  that  the  corporation  has  deferred  distribution 
and  allowed  earnings  to  accumulate  purposely  to  enable  individual 
stockholders  to  evade  payment  of  tax. 


THE   INCOME   TAX  169 

The  fact  that  the  corporation  accumulating  its  earnings  is  a  mere 
holding  company,  or  that  any  corporation  has  accumulated  its  earn- 
ings beyond  the  reasonable  needs  of  its  business,  will  be  considered 
prima  facie  evidence  of  fraudulent  purpose,  under  the  law.  However, 
the  fact  that  earnings  are  allowed  to  accumulate  and  become  surplus 
is  not  to  be  taken  as  evidence  of  intent  to  evade  tax  unless  the  Secre- 
tary of  the  Treasury  holds  that  the  accumulation  is  unreasonable  with 
respect  to  the  needs  of  the  business. 

One  of  the  amendments  carried  by  the  Act  of  October  3,  1917  also 
strikes  at  such  accumulation  by  penalizing  the  corporation  itself  in- 
stead of  the  stockholders  in  the  provision  imposing  an  additional  tax 
at  the  rate  of  10  per  cent  upon  the  amount  of  a  corporation's  net  in- 
come remaining  undistributed  six  months  after  the  close  of  the  tax- 
able year,  provided  such  amount  is  not  actually  invested  or  employed 
in  the  business,  or  retained  for  the  reasonable  requirements  of  the 
business,  or  invested  in  obligations  of  the  United  States  issued  after 
September  1,  1917. 

309.— PREVAILING  RATES  OF  EXCHANGE 
FIX  AMOUNT  OF  FOREIGN  INCOME. 

In  the  case  of  a  citizen  or  resident  of  the  United  States,  or  of  a 
domestic  corporation,  when  income  accruing  from  foreign  invest- 
ments is  not  remitted  to  the  United  States  but  is  placed  to  the  credit 
of  the  individual  or  corporation  in  a  foreign  country,  each  item  of 
such  income  should  be  accounted  for  at  the  rate  of  exchange  prevail- 
ing when  it  is  credited  to  the  account  of  the  individual  or  corporation. 

310.— INTEREST  ACCRUED  ON  BONDS 
AT  TIME  OF  PURCHASE. 

In  the  case  of  a  purchase  of  bonds  between  interest  dates  at  a 
price  covering  not  only  the  principal  of  the  bonds  but  also  the  accrued 
interest  thereon,  the  question  arises  :  How  is  the  purchaser  to  account 
for  the  interest  as  income  when  it  is  received  by  him  in  view  of  the 
fact  that  a  part  of  it  accrued  while  the  bonds  were  under  another 
ownership?  The  position  of  the  Government  is  that  the  purchaser 
shall  account  in  his  return  for  that  part  of  the  interest  payment  which 
accrued  under  his  ownership  and  that  the  person  from  whom  he 
bought  the  bonds  shall  include  in  his  return  that  part  of  the  interest 
which  accrued  prior  to  the  change  in  ownership  of  the  bonds.  As  a 
matter  of  fact,  the  seller  of  the  bonds  in  such  a  transaction  would 
have  received  his  share  of  the  interest  in  advance  when,  in  disposing 


170  THE    INCOME   TAX 

of  the  bonds,  he  was  paid  an  amount  covering  both  principal  and  ac- 
crued interest. 

311.— BOOK  APPRECIATION  AND  DEPRECIATION 
DO  NOT  CREATE  INCOME  AND  LOSS. 

Mere  book  adjustments  of  the  value  of  assets  in  the  accounts  of 
an  individual  or  corporation  do  not  create  either  income  or  loss,  with- 
in the  meaning  of  the  law.  The  writing  down  of  retained  assets  does 
not  constitute  that  kind  of  a  completed  and  closed  transaction  which 
the  Government  insists  shall  occur  before  a  loss  can  be  claimed ;  and, 
conversely,  the  writing  up  does  not  represent  income.  While  a  book 
entry  reflecting  a  reduced  or  an  enhanced  value  of  assets  during  the 
year  may  evidence  a  decrease  or  an  increase  in  the  net  worth  of  the 
individual  or  corporation  for  that  year,  such  decrease  or  increase,  in 
the  case  of  assets  retained  and  under  a  possible  change  of  conditions, 
may  disappear  the  next  year. 

312.— SUIT  TO  RESTRAIN  ASSESSMENT  AND 

COLLECTION  OF  TAX  CANNOT  BE  MAINTAINED. 

Section  3224  of  the  Revised  Statutes  of  the  United  States  -(appli- 
cable to  all  Federal  taxes)  reads  as  follows : 

No  suit  for  the  purpose  of  restraining  the  assessment  or  collection 
of  any  tax  shall  be  maintained  in  any  court. 

This  section  of  the  general  Federal  law  is  specially  applied  to  th* 
income  tax  by  Section  22  of  the  Act  of  September  8,  1916,  reading  as 
follows : 

That  all  administrative,  special,  and  general  provisions  of  law,  in- 
cluding the  laws  in  relation  to  the  assessment,  remission,  collection, 
and  refund  of  internal-revenue  taxes  not  heretofore  specifically  re- 
pealed and  not  inconsistent  with  the  provisions  of  this  title,  are  hereby 
extended  and  made  applicable  to  all  the  provisions  of  this  title  and  to 
the  tax  herein  imposed. 

313.— SUIT  TO  RECOVER  TAXES 

WRONGFULLY  ASSESSED  AND  COLLECTED. 

For  information  with  respect  to  the  procedure  to  be  followed  the 
reader  is  referred  to  paragraphs  entitled  "Must  Precede  Suit  to  Re- 
cover" and  "Two-year  Limitation"  in  chapter  on  "Claims  for  Abate- 
ment and  Refund  of  Taxes." 

314.— TAX  MUST  BE  ASSESSED 

WITHIN  THREE  YEARS— WAIVERS. 

The  law  provides  that  the  Commissioner  shall  assess  an  income 
tax  within  three  years  after  the  return  is  due,  in  the  case  of  neglect 


THE    INCOME   TAX  171 

or  refusal  to  file  a  return  or  of  the  filing  of  an  erroneous  or  false  re- 
turn. This  means  that  in  the  case  of  an  individual  or  a  corporation 
that  should  have  filed  but  did  not  file  a  return  for  the  Calendar  year 
1916,  or  in  the  case  of  an  individual  or  corporation  that  did  file  an 
erroneous  or  false  return  for  that  year,  the  due  date  of  the  return  was 
March  1,  1917.  In  order  to  make  assessment  upon  income  for  that 
year  ( 1916)  the  Commissioner  would  have  to  learn  of  failure  to  file  a 
return,  or  error  or  fraud  in  a  return  filed,  in  sufficient  time  to  enable 
him  to  make  assessment  not  later  than  the  last  day  of  February  in  the 
year  1920. 

The  courts  have  held,  however,  that  there  is  no  limitation  upon 
the  right  of  the  Government  to  sue  for  and  recover  unpaid  taxes,  even 
though  it  is  not  possible  to  follow  the  usual  method  of  assessment 
after  the  expiration  of  three  years.  It  is  not  essential,  therefore,  that 
assessment  be  made.  If  liability  to  original  or  additional  tax  is  Dis- 
covered, the  amount  can  be  recovered  by  suit,  regardless  of  the  fact 
that  no  assessment  has  been  made,  and  regardless  of  the  date  of  the 
discovery  of  the  liability. 

Waiver  of  Limitation. 

In  view  of  the  provisions  of  law,  as  just  explained,  the  Treasury 
Department  has  instructed  Internal  Revenue  field  officers,  whenever 
they  discover  tax  liability  too  late  for  assessment  within  the  three - 
year  period,  to  request  of  the  individual  or  corporation  liable  to  tax 
the  execution  of  a  waiver  of  the  statutory  limitation.  If  such  waiver 
is  executed,  the  Department  says,  the  tax  will  be  assessed  in  the  cus- 
tomary way ;  but,  if  not  executed  as  requested,  the  Government  will 
institute  suit  to  collect. 

315.— INCOME  TO  A  STATE 

FROM  A  PUBLIC  UTILITY. 

The  income  that  may  be  derived  by  any  State,  or  political-subdi- 
vision of  a  State,  or  by  the  Territorial  governments  of  Alaska  and 
Hawaii,  or  by  the  insular  governments  of  the  Philippines  and  Porto 
Rico,  is  protected  from  assessment  of  tax  by  Subdivision  (b)  of  Sec- 
tion 11  of  the  Act  of  September  8,  1916,  which  specifically  provides 
that  such  income  shall  not  be  taxed  and  adds  the  provision  that  when- 
ever any  such  governmental  unit  had,  prior  to  the  passage  of  the  law 
(prior  to  September  8,  1916),  entered  into  a  contract  with  any  person 
or  corporation,  (the  object  and  purpose  of  which  contract  was  "to  ac- 
quire, construct,  operate,  or  maintain  a  public  utility,")  the  income  of 


)72  THE    INCOME   TAX 

the  State,  or  other  governmental  unit  resulting  from  the  performance 
of  the  contract  shall  not  be  taxed.  This  provision  is  not  to  be  con- 
strued, however,  as  exempting  from  tax  the  income  accruing  to  the 
private  contractor. 

Interpreting  the  law,  the  Treasury  Department  holds  in  Treasury 
Decision  2090  that— 

"where  a  portion  of  the  net  earnings  of  such  public  utility  is  pay- 
able under  such  contract  to  the  State,  Territory,  etc.,  the  amount  so 
paid  may  be  deducted  by  the  public  utility  operating  under  such  con- 
tract as  an  'expense  of  business/  " 

316.— WHEN  RECORD  OWNER  OF  STOCK 
IS  NOT  ACTUAL  OWNER. 

It  frequently  is  true  that  stock  is  recorded  in  the  name  of  a  per- 
son or  corporation  when  such  person  or  corporation  is  not  the  actual 
owner  and  does  not  benefit  by  the  dividends  paid.  In  such  a  case,  pro- 
vided the  actual  owner  is  a  citizen  or  resident  (individual)  of  the 
United  States,  or  a  domestic  corporation,  the  record  owner  simply 
ignores  the  payment  of  a  dividend  in  making  his  or  its  return  and  the 
actual  owner  accounts  for  the  dividend  as  income. 

317.— INTEREST  RECEIVED  ON  BONDS 
OF  EXEMPT  CORPORATIONS. 

While  the  law  specifically  exempts  from  tax  the  income  of  certain 
classes  of  corporations  of  a  general  public,  mutual,  social,  and  fra- 
ternal character  (see  chapter  on  "Corporations  Exempt"),  it  does  not 
exempt  from  tax  the  interest  paid  on  bonds  issued  by  such  corpora- 
tions, This  interest  is  not  income  of  the  exempt  corporations ;  it  is 
income  of  the  bondholders  and  when  such  bondholders  (individual  or 
corporate)  are  otherwise  taxable  they  must  include  the  interest  in 
their  returns  and  subject  it  to  tax.  A  case  in  point  would  be  the  in- 
terest paid  on  bonds  of  the  California  Country  Club  to  John  Doe.  The 
club  is  exempt  but  John  Doe  is  not ;  therefore  John  Doe  includes  the 
interest  in  his  return. 

318.— ACCOUNTS  UPON  BASIS  OTHER  THAN 

ACTUAL  RECEIPTS  AND  DISBURSEMENTS. 

It  has  been  deemed  advisable  to  refer  again  to  those  provisions  of 
the  Act  of  September  8,  1916  which  give  both  an  individual  and  a  cor- 


THE    INCOME   TAX  173 

poration  the  right  to  make  a  return  upon  a  basis  other  than  one  of 
actual  receipts  and  disbursements  during  the  year  when  the  tax- 
payer's accounts  are  kept  on  some  other  basis. 

The  first  condition  to  the  enjoyment  of  this  privilege  is  that  the 
system  of  accounting  shall  reflect  income ;  the  second  is  that  it  shall 
be  subject  to  regulations  made  by  the  Treasury  Department.  The 
question  of  regulations  is,  therefore,  the  question  in  which  the  tax- 
payer is  interested. 

The  Department  has  been  general  and,  necessarily  indefinite,  in 
its  instructions.  And,  obviously,  this  attitute  is  essential  to  allowance 
of  the  leeway  plainly  intended  by  Congress. 

"This  office  requires  no  special  system  of  bookkeeping,"  says  the 
Department  in  Treasury  Decision  2161,  "neither  does  it  require  any 
specific  method  by  which  the  net  income  to  be  returned  by  corpora- 
tions shall  be  determined." 

Further  in  Article  158  of  Regulations  No.  33,  it  explains  as  fol- 
lows : 

"It  is  immaterial  whether  the  deductions  except  for  taxes  and 
losses  are  evidenced  by  actual  disbursements  in  cash,  or  whether  evi- 
denced in  such  other  way  as  to  be  properly  acknowledged  by  the  cor- 
porate .officers  and  so  entered  on  the  books  of  the  corporation  as  to 
constitute  a  liability  against  the  assets  of  the  corporation  making  the 
return.  Except  as  the  same  may  be  modified  by  the  provisions  of  this 
Act,  limiting  certain  deductions  and  authorizing  others,  the  net  in- 
come as  returned  for  the  purpose  of  the  tax  should  be  the  same  as 
that  shown  by  the  books  or  the  annual  balance  sheet." 

And  in  Article  183  of  Regulations  No.  33,  the  Department  adds: 

"The  books  of  a  corporation  are  assumed  to  reflect  the  facts  as 
to  its  earnings,  income,  etc.  Hence  they  will  be  taken  as  the  best 
guide  in  determining  the  net  income  upon  which  the  tax  imposed  by 
this  Act  is  calculated.  Except  as  the  same  may  be  modified  by  the 
provisions  of  the  law,  wherein  certain  deductions  are  limited,  the  net 
income  disclosed  by  the  books  and  verified  by  the  annual  balance 
sheet,  or  the  annual  report  to  stockholders,  should  be  the  same  as  that 
returned  for  taxation." 

In  Treasury  Decision  2433,  issued  under  date  of  January  8,  1917. 
are  to  be  found  the  latest  instructions  from  the  Department.  Even 
though  these  instructions,  or  regulations,  have  been  elsewhere  in  this 
book  referred  to,  it  has  been  deemed  advisable  to  give  their  require- 
ments in  full  here.  After  quoting  the  provision  of  law  authorizing  the 


174  THE    INCOME    TAX 

filing  of  a  return  by  a  corporation  upon  some  other  basis  than  that  of 
actual  receipts  and  disbursements,  the  Department  rules  as  follows  : 

Under  this  provision  it  will  be  permissible  for  corporations  which  accrue 
on  their  books  monthly  or  at  other  stated  periods,  amounts  sufficient  to  meet 
fixed  annual  or  other  charges,  to  deduct  from  this  gross  income  the  amounts 
so  accrued,  provided  such  accruals  approximate  as  nearly  as  possible  the 
actual  liabilities  for  which  the  accruals  are  made,  and  provided  that  in  cases 
wherein  deductions  are  made  on  the  accrual  basis  as  hereinbefore  indicated, 
income  from  fixed  and  determinable  sources  accruing  to  the  corporations  must 
be  returned,  for  the  purpose  of  the  tax,  on  the  same  basis. 

In  cases  wherein,  pursuant  to  the  consistent  practice  of  accounting  of 
the  corporation,  or  pursuant  to  the  requirements  of  some  Federal,  state,  or 
municipal  supervising  authority,  corporations  set  up  and  maintain  reserves  to 
meet  liabilities,  the  amount  of  which  and  the  date  of  payment  or  maturity  of 
which,  is  not  definitely  determined  or  determinable  at  the  time  the  liability 
is  incurred,  it  will  be  permissible  for  the  corporations  to  deduct  from  their 
gross  income  the  amounts  credited  to  such  reserves  each  year,  provided 
that  the  amounts  deductible  on  account  of  the  reserves  shall  approximate  as 
nearly  as  can  be  determined,  the  actual  amounts  which  experience  has  demon- 
strated would  be  necessary  to  discharge  the  liabilities  incurred  during  the  year 
and  for  the  payment  of  which  additions  to  the  reserves  were  made;  and  pro- 
vided if  it  shall  be  found  that  the  amount  credited  to  any  such  reserve  is  in 
excess  of  the  reasonable  or  probable  needs  of  the  corporation  to  meet  and 
discharge  the  liabilities  for  which  the  reserve  is  credited,  the  excess  of  such 
reserves  over  and  above  the  reasonable  or  probable  needs  for  the  purpose 
indicated,  shall  be  at  once  disallowed  as  a  deduction  and  restored  to  income 
for  the  purpose  of  the  tax;  and  provided  further,  that  in  no  event  will  sink- 
ing funds  or  other  reserves  set  up  to  meet  additions,  betterments  or  other 
capital  obligations,  constitute  allowable  deductions  from  gross  income. 

This  ruling  contemplates  that  the  income  and  authorized  deductions  shall 
be  computed  and  accounted  for  on  the  same  basis,  and  that  the  same  practice 
shall  be  consistently  followed  year  after  year.  Amounts  paid  in  discharge 
of  any  liability  or  obligation  for  which  a  reserve  has  been  set  up,  as  herein- 
before outlined,  will,  when  paid,  be  charged  to  the  reserve  created  to  meet 
it,  in  so  far  as  such  reserve  is  sufficient  to  meet  the  liability,  provided  always 
that  the  liability  is  of  a  character,  which  constitutes  an  allowable  deduction 
within  the  meaning  of  the  law. 

If,  upon  investigation,  it  shall  be  found  that  returns  made  upon  the  basis 
of  accruals  and  reserves,  do  not  reflect  the  true  net  income,  the  corporation 
so  failing  in  this  way  to  return  the  true  net  income,  will  not  thereafter  be 
permitted  to  make  its  returns  upon  any  basis  other  than  that  of  actual  receipts 
and  disbursements. 

The  reserves  contemplated  by  the  foregoing  ruling,  are  those  reserves 
only,  which  are  set  up  to  meet  some  actual  liability  incurred,  the  amount 
necessary  to  discharge  which  can  not  at  the  time  be  definitely  determined, 
and  do  not  contemplate  reserves  to  meet  losses  contingent  upon  shrinkage  in 
values,  losses  from  bad  debts,  capital  investments,  etc.,  which  losses  are  de- 
ductible only  when  definitely  determined  as  the  result  of  a  closed  or  com- 
pleted transaction,  and  are  charged  off. 

The  above  instructions  from  the  Department  refer  to  corpora- 
tions but  are  plainly  applicable  to  individuals  in  view  of  the  provision 
of  law  giving  the  individual  the  same  rights  as  a  corporation  in  this 
respect. 

319.— CORPORATIONS  DOING  BUSINESS  IN 
PHILIPPINES   AND  PORTO  RICO. 

The  law  provides  that  a  corporation  shall  make  its  return  to  the 
Collector  of  Internal  Revenue  of  the  district  in  which  it  has  its  prin- 


THE    INCOME   TAX  175 

cipal  place  of  business.  The  Act  of  September  8,  1916,  (Regular  In- 
come Tax)  was  made  effective  in  both  the  Philippines  and  Porto  Rico, 
but  with  the  proviso  that  the  administration  of  the  law  and  collec- 
tion of  the  tax  should  be  left  to  the  officials  of  the  insular  govern- 
ments and  that  all  revenue  should  go  intact  to  such  governments. 
The  Department's  interpretation  of  these  provisions  and  their  relation 
to  each  other  is 

(a)  that  a  corporation,  even  though  incorporated  in  the  United 
States,  should  make  return  and   pay   tax  in  the  Philippines  or  Porto 
Rico,  if  its  business  is  done  wholly  in  either  insular  possession  ; 

(b)  that  a  corporation  with  its  principal  place  of  business  (that 
is,  where  are  kept  its  books  of  account  and  other  data  from  which  a 
-eturn  must  be  made)  in  the  United  States,  but  doing  business  in  the 
islands,  should  make  return  and  pay  in  the  United  States  ; 

(c)  that  if  a  corporation  has  its  principal  place  of  business  in  the 
United  States  and  a  branch  in  the  Philippines  or  Porto  Rico,  it  should 
make  return  and  pay  tax  in  the  United  States  and  include  in  its  return 
all  the  income  of  its  insular  branch  office. 

[Note:  The  term  "United  States/'  as  used  above  does  not  include 
either  the  Philippines  or  Porto  Rico.] 

War  Income  Tax  Different. 

Such  is  the  application  of  the  Act  of  September  8,  1916  to  the 
Philippines  and  Porto  Rico  and  so  must  returns  under  that  act  (for 
the  Regular  Income  Tax)  be  made. 

But  there  is  a  clause  in  the  War  Income  Tax  section  of  the  War 
Revenue  Act  of  October  3,  1917,  which  not  only  states  that  the  War 
Income  Tax  is  not  applicable  to  the  Philippines  and  Porto  Rico  but 
also  gives  to  the  Philippine  and  Porto  Rican  legislatures  power  "to 
amend,  alter,  modify,  or  repeal  the  income  tax  laws  in  force"  in  the 
islands. 

With  the  statutes  as  they  stand  at  this  writing,  a  situation  has 
therefore  resulted  in  which  certain  taxpayers  (individual  and  corpor- 
ate) resident  in  the  Philippines  or  Porto  Rico,  must  make  return  and 
pay  tax  to  their  respective  insular  governments  for  the  Regular  In- 
come Tax  (Act  of  September  8,  1916)  but  not  for  the  War  Income  Tax 
(Act  of  October  3,  1917.)  This  situation  may,  however,  be  changed  at 
any  time  by  either  insular  legislature  repealing  or  altering  the  provi- 
sions of  the  Act  of  September  8,  1916  as  they  apply  to  the  territory 
within  its  legislative  jurisdiction. 


176  THE    INCOME    TAX 

320.— RULING  TAXING  FOREIGN 
GOVERNMENTS  NULLIFIED. 

One  of  the  new  provisions  added  to  the  Act  of  September  8,  1916 
by  the  War  Revenue  Act  provides  that  nothing  in  the  law  shall  be 
construed  as  taxing  the  income  of  foreign  governments  from  invest- 
ments in  American  securities  or  from  interest  on  deposits  in  American 
banks.  This  is  a  nullification  of  Treasury  Decision  2425  of  December 
28,  1916  in  which  the  Department  construed  subdivision  (g)  of  Section 
9  of  the  Act  of  September  8,  1916  as  taxing  foreign  governments  pn 
such  income  and  demanded  that  returns  be  filed  by  the  representatives 
of  such  governments  in  the  United  States. 

321.— INVESTIGATION  OF  RETURNS 
BY  GOVERNMENT. 

The  Commissioner  of  Internal  Revenue  has  authority  to  have  the 
affairs  of  any  taxpayer  investigated  for  the  purpose  of  verifying  a  re- 
turn of  income.  He  delegates  this  authority  to  field  officers  of  In- 
ternal Revenue — deputy  collectors,  inspectors  and  agents — who  gen- 
erally work  under  the  immediate  local  supervision  of  an  Internal 
Revenue  Agent,  cooperating  with  the  Collector. 

One  of  these  officers,  appearing  to  begin  an  investigation,  should 
be  requested  to  show  his  authority  .  This  he  will  always  do,  and  his 
evidence  of  authority  will  always  be  either  a  letter  of  assignment  to 
the  particular  investigation  or  his  pocket  commission.  The  taxpayer 
should  insist  upon  the  production  of  this  evidence.  This  suggestion  is 
made  because  Internal  Revenue  officers,  as  all  other  Federal  officers, 
are  sometimes  impersonated  by  those  without  official  connection  but 
with  an  ulterior  purpose  to  serve. 

If,  as  a  result  of  the  investigation,  additional  tax  is  assessed,  the 
individual  or  corporation  should  always  insist  upon  an  explanation  of 
the  increase  before  paying  it.  The  taxpayer  has  a  right  to  such  ex- 
planation and  the  Collector  has  the  authority  and  all  the  necessary 
data  at  hand  to  furnish  it.  This  suggestion  is  made  because  frequent- 
ly a  taxpayer  receives  notice  of  an  increase  of  tax  without  an  explana- 
tion of  the  basis  of  the  increase. 

If,  after  considering  the  explanation,  the  taxpayer  feels  that  the 
additional  assessment  is  unjust  or  erroneous,  payment  of  the  tax  can 
be  deferred  and  the  matter  can  be  submitted  to  the  Department, 
through  the  office  of  the  Collector,  in  a  claim  for  abatement  of  the 
assessment.  (See  chapter  "Claims  for  Abatement  and  Refund  of 
Tax"). 


THE    INCOME   TAX  177 

Request  for  Explanation. 

Again,  instead  of  the  appearance  of  a  field  officer,  there  will  come 
d  letter  from  the  Department  at  Washington,  or  from  the  Collector, 
calling  attention  to  certain  items  of  deduction  that  have  appeared  in 
a  return  and  requesting  further  information  regarding  them.  Such 
a  letter  usually  gives  a  limited  time  for  reply  (for  example,  30  days), 
the  alternative  being  a  disallowance  of  the  questioned  item  and  an  in- 
crease of  assessment.  The  taxpayer  should  comply  with  the  request 
within  the  time  specified  in  the  letter. 

Books  Cannot  Be  Withheld. 

Books  of  account  and  other  records  cannot  be  withheld  from  an 
investigating  officer.  The  officer  can  report  to  the  Collector,  who  has 
ample  authority  to  take  possession  of  any  books  and  records  and  to 
summon  and  put  under  oath  any  witness  essential  to  the  investiga- 
tion. 

322.— INFORMATION   CONFIDENTIAL. 

Internal  Revenue  officers  cannot  divulge  any  information  ob- 
tained while  acting  in  their  official  capacity  or  any  fact  disclosed  by  a 
return  of  income,  or  any  other  tax  return.  All  information  must  be 
kept  inviolable. 

323.— HOW  RETURNS  ARE  OPEN 
TO  INSPECTION. 

All  returns  must  be  transmitted  to  the  office  of  the  Commissioner 
of  Internal  Revenue  in  Washington,  D.  C.,  for  permanent  filing. 

While  the  law  says  that  the  returns  "shall  constitute  public 
records  and  be  open  to  inspection  as  such,"  it  provides  that  such  "in- 
spection" shall  be  only  upon  the  order  of  the  President,  under  rules 
to  be  prescribed  by  the  Secretary  of  the  Treasury  and  approved  by 
the  President.  The  statute  itself,  however,  adds  that  the  proper  offi- 
cers of  any  State  imposing  a  general  income  tax  may,  upon  the  re- 
quest of  the  Governor,  have  access  to  the  returns,  (or  to  an  abstract 
of  them)  showing  the  name  and  income  of  each  corporation — but  also 
under  rules  prescribed  by  the  Secretary  of  the  Treasury. 

324.— GAIN  OR  LOSS  IN  SALE  OF 
PROPERTY  BY  LEGATEE. 

When  property  is  sold  or  otherwise  disposed  of  for  an  amount 
more  or  less  than  cost,  if  acquired  on  or  after  March  1,  1913.  or  more 


178  THE    INCOME   TAX 

or  less  than  the  fair  market  value  of  the  property  as  of  March  1.  1913, 
if  acquired  prior  to  that  date,  the  gain  must  be  included  in  income  or 
the  loss  can  be  deducted  if  otherwise  such  loss  meets  the  require- 
ments relative  to  deductible  losses. 

However,  in  the  case  of  property  acquired  by  a  legatee,  the  De- 
partment has  ruled  that  when  an  individual  dies  on  or  after  March  1, 
1913,  leaving  property,  gain  or  loss  resulting  from  a  subsequent  sale 
by  the  legatee  should  be  computed  on  the  basis  of  the  appraised  value 
of  the  property  at  the  time  of  death. 

325.— PERMANENT   IMPROVEMENTS 
MADE  UNDER  LEASE. 

Where,  under  the  terms  of  a  lease,  a  tenant  agrees  to  erect  a 
building  or  make  certain  fixed  improvements,  the  difference  between 
the  cost  of  the  building  or  improvements  and  a  reasonable  allowance 
for  the  exhaustion,  wear  and  tear  of  the  property  while  under  the 
lease  is  gain  to  be  accounted  for  by  the  lessor.  In  such  circumstances 
the  tenant  can  prorate  the  cost  of  the  building  or  improvement  over 
the  life  of  the  lease  and  deduct  as  an  expense  of  business  in  the  return 
for  each  year  one  year's  prorata  of  the  cost.  In  other  words,  the  ten- 
ant practically  regards  such  expense  as  rental.  The  lessor,  however, 
does  not  have  to  account  for  his  gain  from  the  acquisition  of  the  build- 
ing or  improvements  until,  at  the  expiration  of  the  lease,  the  building 
or  improvements  come  into  his  possession. 

326.— BROKERAGE   INTEREST 
RECEIVED  AND  PAID. 

A  decision  of  interest  to  a  corporation  engaged  in  the  brokerage 
business  is  that  in  the  case  of  Altheimer  &  Rawlings  Investment  Co. 
v.  Allen  Collector  (U.  S.  District  Court  for  the  Eastern  Division  of  the 
Kastern  District  of  Missouri.)  According  to  the  facts  in  that  case,  the 
corporation  did  a  brokerage  business  and  bought  securities  for  its 
customers.  The  customers  paid  only  part  of  the  purchase  price,  but 
paid  interest  on  balances.  And  the  corporation,  in  buying  the  securi- 
ties, paid  only  a  part  of  the  purchase  price,  leaving  balances  on  which 
it  likewise  paid  interest. 

In  making  its  return  of  income  the  brokerage  corporation  in- 
cluded in  gross  income  the  difference  between  interest  received  and 
interest  paid  out.  The  Court  held  this  method  to  have  been  incorrect, 
stating  that  the  corporation  should  have  included  in  gross  income  the 
amount  of  interest  received  from  its  customers  and  that  it  was  en- 
titled to  a  deduction  for  interest  paid  out. 


THE    INCOME   TAX  179 

327.— TIMBER  AND  LUMBER  COMPANIES- 
SPECIAL  RULES. 

The  Department  has  several  times  changed  its  rulings  with  refer- 
ence to  the  method  to  be  followed  in  making  return  of  income  from  a 
property  consisting  of  timber  and  timber  lands  when  the  timber  is 
either  sold  as  such  or  is  manufactured  into  lumber.  The  latest  and 
controlling  ruling,  issued  in  an  official  letter  under  date  of  March  10, 
1917,  is  as  follows : 

Corporations  owning  timber  lands  and  logging  off  the  timber  and 
manufacturing  it  into  lumber,  will,  if  the  timber  was  acquired  prior  to 
March  1,  1913,  be  permitted  to  exclude  from  gross  income  either 
through  a  deduction  from  gross  receipts  or  through  a  charge  into  the 
cost  of  manufacturing  the  timber  into  lumber,  an  amount  equivalent  to 
the  fair  market  price  or  value  of  the  standing  timber  as  of  March  1, 
1913. 

In  order  to  secure  the  benefit  of  this  deduction  such  corporations 
must  set  up  on  their  books,  as  of  March  1,  1913,  the  fair  market  price  en 
bloc  of  all  the  timber  then  owned  by  them,  and  then,  by  dividing  this  en 
bloc  value  by  the  estimated  number  of  feet  (board  measure)  in  the  en- 
tire timber  holdings,  the  per  unit  price  or  value  as  of  March  1,  1913  will 
be  ascertained,  which  per  unit  price  or  value  will  be  the  basis  for 
measuring  the  amount  which  may  be  added  to  the  cost  of  manufacture, 
or  deducted  from  gross  income,  until  the  en  bloc  value  of  the  entire 
holdings,  as  of  March  1,  1913,  shall  have  been  extinguished,  after  which 
no  further  deduction  on  this  account  shall  be  allowed. 

The  same  rule  will  apply  in  the  case  of  timber  or  timber  lands  pur- 
chased subsequent  to  March  1,  1913,  the  only  difference  being  that 
actual  cost,  that  is,  the  gross  purchase  price,  shall,  in  making  the  com- 
putation, be  substituted  for  en  bloc  price  or  value  as  of  that  date. 

If  the  entire  market  price  or  value  of  both  timber  and  lands,  as  of 
March  1,  1913,  or  the  entire  cost,  if  acquired  subsequent  to  that  date, 
is  extinguished  through  a  deduction  from  gross  income  for  timber  used, 
or  through  a  per  unit  charge  to  cost  of  manufacturing  lumber,  then  the 
entire  amount  realized  from  the  logged-off  lands  or  for  other  salvage 
will  be  returned  as  income  of  the  year  in  which  such  lands  are  sold  or 
disposed  of. 

If  the  timber  or  timber  lands  are  sold  en  bloc,  the  gain  or  loss  will 
be  ascertained  on  the  basis  of  the  difference  between  the  fair  market 
price  or  cost  and  the  selling  price,  accordingly  as  the  property  was  ac- 
quired prior  or  subsequent  to  March  1,  1913. 

The  fair  market  price  or  value  of  timber  or  timber  lands,  as  of 
March  1,  1913,  is  the  price  at  which  the  property  in  its  then  condition 
and  with  the  circumstances  then  surrounding  it,  could  have  been  sold 
for  cash  or  its  equivalent.  This  value  must  not  be  speculative,  but 
must  be  determined  without  taking  into  account  any  prospective  profits 
that  may  result  from  the  manufacture  of  the  timber  into  lumber.  It 
must  be,  as  the  law  contemplates,  a  fair  market  value,  and,  once  de- 
termined, must  be  set  up  on  the  books,  and,  as  the  measure  of  a  stump- 
age  deduction  for  income  tax  purposes  must  remain  constant  and  can- 
not be  increased.  The  value  so  set  up,  as  of  March  1,  1913,  will  be  sub- 
ject to  the  approval  of  the  Commissioner  of  Internal  Revenue. 

The  ruling  contained  in  the  above  regulation  will  refer  equally  as 
well  to  the  years  1913,  1914  and  1915,  with  the  exception  that  the  cost 
of  the  timber  shall  be  the  governing  basis  instead  of  its  value  as  of 
March  1,  1913.  (Note — The  provision  relative  to  fair  market  price  or 
value  as  of  March  1,  1913  did  not  appear  in  the  law  prior  to  passage  of 
the  Act  of  September  8,  1916.) 


180  THE    INCOME   TAX 

With  reference  to  the  regulation  just  quoted,  it  is  suggested  that 
the  taxpayer  in  making  return  state  what  is  believed,  in  such  tax- 
payer's opinion,  to  be  the  fair  market  price  or  value  of  the  timber  as 
of  March  1,  1913,  and  give  reasons  for  such  conclusion.  If  the  figure 
does  not  meet  with  the  approval  of  the  Treasury  Department,  the  De- 
partment can  only  take  the  matter  up  with  the  taxpayer  for  further 
discussion  and,  if  then  not  satisfied,  reduce  the  amount  and  increase 
assessment  accordingly.  No  penalty  can  be  incurred. 

While  the  ruling  refers  only  to  corporations  owning  and  operat- 
ing timber  properties,  it  is  applicable  to  individuals  engaged  in  and 
making  returns  of  income  from  the  same  kind  of  business. 

328.— RESPONSIBILITY  FOR  TAX 

OF  DISSOLVED  CORPORATION. 

When  a  corporation  is  dissolved  or  liquidated  during  the  year,  it 
is  required  to  make  a  final  return.  This  final  return  may  be  made 
either  at  the  time  of  dissolution  or  within  the  time  prescribed  for  a 
return  for  that  year — preferably,  however,  at  the  time  of  dissolution. 
If  any  tax  is  shown  to  be  due,  the  officers  of  the  corporation  should 
retain  sufficient  funds  to  pay  it.  The  Government  holds  them  respon- 
sible. 

329.— ORGANIZATION  EXPENSES  CANNOT 
BE  DEDUCTED  BY  CORPORATION. 

The  organization  expenses  of  a  corporation  have  been  held  not  to 
be  deductible  in  the  corporation's  return  of  income.  By  such  expenses 
are  meant  expenditures  in  the  employment  of  attorneys,  accountants, 
the  payment  of  State  fees  and  the  other  expenses  connected  with  the 
incorporation  and  organization  of  the  company.  An  expense  of  this 
kind  is  held  to  be  a  capital  expense,  offset  by  the  value  of  the  corpora- 
tion's franchise,  and  not  "an  ordinary  and  necessary  expense  of  main- 
tenance and  operation,"  the  kind  allowed  to  be  deducted,  in  the  lan- 
guage of  the  law. 

330.— INCOME  PAID  IN  LIBERTY  BONDS. 

The  question  having  arisen  as  to  whether  a  dividend  paid  in 
Liberty  Loan  Bonds  was  returnable  for  tax,  the  Treasury  Department 
submitted  the  matter  to  the  Attorney  General  of  the  United  States. 
As  the  bond  issue  in  question  was  the  first,  the  Attorney  General 
based  his  opinion  upon  the  act  authorizing  that  issue  and  held  as  fol- 
lows : 

"The  Act  of  April  24,  1917  provides  as  to  the  bonds  thereby  au- 
thorized that 


THE    INCOME   TAX  181 

"  'the  principal  and  interest  thereof  ....  shall  be  exempt, 
both  as  to  principal  and  interest,  from  all  taxation,  except  estate  or 
inheritance  taxes,  imposed  by  authority  of  the  United  States,  or  its 
possessions,  or  by  any  State  or  local  taxing  authority.' 

"Like  every  exemption  from  taxation,  this  provision  must  be  lit- 
erally construed  and  cannot  be  extended  beyond  its  precise  terms.  It 
protects  an  owner  of  these  bonds  from  any  tax  of  whatever  character, 
except  estate  or  inheritance  taxes,  levied  upon  them  by  reason  of  his 
possession  and  ownership ;  but  a  tax  levied  upon  one's  net  income  or 
annual  gain  cannot  be  evaded  because  the  income  or  gain  happens  to 
be  liquidated  by  the  delivery  of  a  certain  number  of  these  bonds  or 
other  non-taxable  securities.  Such  a  tax  is  upon  the  income  itself  as 
an  entirety  and  not  upon  the  specific  articles  into  which  this  income  is 
finally  transmuted.  When  these  bonds,  therefore,  are  used  as  a  medium 
of  payment,  whether  in  the  discharge  of  a  private  debt  or  a  corporate 
dividend,  the  profit  or  gain  to  the  recipient  is  nevertheless  subject  to 
income  tax." 

The  Attorney  General's  opinion  would  be  just  as  applicable  to  in- 
come in  the  payment  of  which  the  bonds  (Liberty  Loan  of  Second 
Series)  or  certificates  authorized  by  the  Act  of  September  24,  1917  are 
used  as  the  medium  of  payment.  In  other  words,  while  the  interest 
paid  on  the  bonds  themselves  is  taxable  as  income  only  as  specifically 
prescribed  in  the  Act  of  September  24,  1917  with  respect  to  the  second 
series,  the  exemption  does  not  extend  to  any  other  kind  of  income 
paid  in  bonds — where  the  bonds  as  a  medium  of  payment  become  the 
equivalent  of  cash. 

The  Department  has  therefore  held  that  a  payment  of  income  in 
bonds — for  instance,  the  payment  of  a  dividend  by  the  distribution  of 
such  bonds  to  the  stockholders — is  taxable  to  the  recipient. 

For  the  sake  of  clarity  the  exemptions  with  respect  to  the  subjec- 
tion of  the  interest  paid  on  the  bonds  to  income  tax  should  be*  stated 
here  again.  They  are  as  follows : 

Liberty  Loan  Bonds  (First  Series) — both  principal  and  interest 
exempt  from  all  taxes,  both  Federal  and  local,  except  estate  and  in- 
heritance taxes. 

Liberty  Loan  Bonds  (Second  Series) — both  principal  and  interest 
exempt  from  all  taxes,  both  Federal  and  local,  except  (a)  estate  or  in- 
heritance taxes  and  (b)  graduated  additional  income  tax  and  excess 
profits  tax.  However,  in  the  case  even  of  the  graduated  additional  in- 
come tax  or  excess  profits  tax  the  recipient  of  the  interest  enjoys  ex- 
emption to  an  amount  not  in  excess  of  the  interest  on  bonds  of  a  prin- 
cipal of  $5,000. 


182  THE    INCOME  TAX 

The  entire  amount  of  interest  received  on  bonds  of  both  series  is 
exempt  from  the  normal  income  tax. 

331.— IN  DISPUTED  TAX  CASE 

ABATEMENT  CLAIM  STAYS  PENALTY. 

When  a  tax  has  been  assessed  and  demand  made  for  its  payment 
and  the  person  or  corporation  assessed  objects  to  payment  on  the 
ground  that  the  tax  is  unjust  or  erroneous,  such  person  or  corporation 
has  the  right  to  file  with  the  Collector  a  claim  for  the  abatement  of  the 
assessment.  If  this  claim  is  filed  within  ten  days  after  the  receipt  of 
demand  for  payment,  the  time  ceases  to  run  against  the  claimant  as 
to  the  5  per  cent  penalty  provided  for  delinquency  in  payment.  In 
other  words,  if  the  claim,  is  eventually  rejected  and  another  demand 
made  for  payment,  the  5  per  cent  penalty  does  not  accrue  when  pay- 
ment is  made  within  ten  days  of  such  additional  demand.  However, 
interest  at  the  rate  of  one  per  cent  a  month  accrues  from  the  date  the 
time  given  in  the  first  ten-days  demand  expired  until  date  of  actual 
payment.  (For  instructions  relative  to  filing  claim  for  abatement  see 
chapter  on  "Claims  for  Abatement  and  Refund  of  Tax.") 

332.— DEVELOPMENT  CHARGES  ON  A  FARM. 

In  passing  upon  field  officers'  reports  of  investigations  the  De- 
partment has  taken  the  position  that  it  prefers  to  consider  that  all 
money  expended  in  connection  with  a  farm  or  ranch  prior  to  the  time 
the  property  reaches  a  productive  stage  represents  an  investment  of 
capital  and  should  not  be  a  deduction  in  a  return  of  income. 

333.— WHEN  ACTUAL  OWNER  IS 
NOT  OSTENSIBLE  OWNER. 

Another  case  has  arisen  in  connection  with  the  practical  adminis- 
tration of  the  law  where  the  following  condition  was  found : 

A  farming  property  in  the  name  of  Mr.  John  Doe  and  actively 
operated  by  him  was  found  to  have  been  purchased  with  his  wife's 
money.  John  Doe  objected  to  making  return  of  the  income,  insisting 
that,  although  he  had  been  the  ostensible  owner,  the  property  really 
belonged  to  his  wife.  The  field  officer  declined  to  accede  to  his  re- 
quest, but  the  Department  overruled  the  field  officer  and  directed  that 
both  income  and  deductions  in  connection  with  the  property  be  ac- 
counted for  in  the  return  filed  by  the  wife. 


THE    INCOME   TAX  183 

334.— INTEREST  AND  TAXES  ON 
RESIDENCE  DEDUCTIBLE. 

While  the  income  tax  law  does  not  allow  an  individual  in  deduct- 
ing the  expenses  of  business  to  include  any  personal,  living  or  family 
expenses  it  does  under  the  allowances  for  deduction  of  interest  and 
taxes  permit  him  to  deduct  interest  paid  on  money  borrowed  to  build 
a  home  or  to  meet  personal  or  family  expenses  ;  also  it  allows  him  to 
deduct  taxes  paid  on  his  residence  and  personal  property.  The  deduc- 
tions for  interest  and  taxes  are  not  restricted  to  expenditures  in  con- 
nection with  the  individual's  business.  In  cases  where  field  officers 
have  disallowed  deductions  of  interest  and  tax  payments  of  this  kind, 
they  have  been  overruled  by  the  Department. 

335.— LOSS  FROM  ENDORSEMENT 
OF  NOTE  ALLOWABLE. 

The  loss  sustained  by  an  individual  by  reason  of  having  to  pay  a 
note  which  he  has  endorsed  can  be  deducted  as  a  bad  debt  for  the 
year  in  which  paid,  provided  the  endorser  is  unable  to  obtain  reim- 
bursement from  the  maker  of  the  note. 

336.— PAYMENT  BY  NOTE 

REPRESENTS   INCOME. 

The  Department  has  held  that  income  paid  by  promissory  note 
must  be  returned  for  tax.  The  question  came  up  particularly  in  con- 
nection with  a  rental  payment  of  $1500  a  month.  The  tenant  was  not 
able  to  make  full  payment  in  cash,  but  did  pay  $750  in  cash  and  $750 
by  note  each  month.  The  landlord  was  required  at  the  end  of  the 
year  to  return  the  entire  amount  of  the  rental,  $18,000,  as  income  for 
tax.  The  Department  held  that  a  promissory  note  should  be  re- 
garded as  the  equivalent  of  cash.  Subsequently,  if  the  landlord 
should  be  unable  to  collect  on  the  notes,  he  would  be  allowed  a  de- 
duction on  account  of  bad  debts  against  the  income  of  the  year  in 
which  he  found  the  notes  to  be  worthless. 

337.— DIVIDENDS  RECEIVED  BY  ONE 
CORPORATION   FROM   ANOTHER. 

In  considering  the  two  income  tax  laws  now  in  effect — the  Act  of 
September  8,  1916  (termed  in  this  book  the  "Regular  Income  Tax") 
and  the  Act  of  October  3,  1917  (termed  in  this  book  the  "War  Income 


184  THE    INCOME   TAX 

Tax") — the  taxpayer  must  regard  in  two  ways  the  dividends  which 
one  corporation  receives  from  another  corporation  also  subject  to  in- 
come tax. 

In  the  computation  of  the  tax  imposed  by  the  Act  of  September  8, 
1916  (Regular  Income  Tax)  at  the  rate  of  2  per  cent  one  corporation 
must  include  in  its  gross  income  the  entire  amount  of  dividends  re- 
ceived on  the  stock  of  another  corporation  and  is  not  allowed  any 
credit  or  deduction  on  such  account. 

But  in  the  computation  of  the  tax  imposed  by  the  Act  of  October 
3,  1917  (War  Income  Tax)  at  the  additional  rate  of  4  per  cent  a  cor- 
poration is  allowed  a  credit  for  the  amount  received  as  dividends  on 
the  stock  of  another  corporation  subject  to  the  tax. 

The  Holding  Company. 

Under  the  Act  of  September  8,  1916  it  often  happens  that  the  en- 
tire gross  income  of  a  holding  company  consists  of  dividends  received 
on  the  stock  of  the  operating  company.  Both  corporations  have  to 
make  return  and  pay  tax  on  total  net  income.  Each  corporation  is  re- 
garded as  a  distinct  and  taxable  entity.  In  such  a  case  the  net  income 
of  the  operating  company  may  be  practically  the  gross  income  of  the 
holding  company  and  the  holding  company's  allowable  deductions 
may  be  almost  inconsiderable ;  nevertheless,  the  income  from  the 
operation  of  the  property  does,  before  it  reaches  the  individual  parties 
at  interest  (the  stockholders  of  the  holding  company)  become  subject 
to  two  assessments  of  income  tax — one  against  the  income  of  the 
operating  company  and  the  other  against  the  income  of  the  holding 
company.  The  Department  has  insisted  upon  a  full  return  from  every 
holding  or  subsidiary  corporation  maintaining  a  corporate  existence 
of  its  own. 

338.— VALUE  OF  STOCK  DIVIDEND. 

One  of  the  amendments  to  the  Act  of  September  8,  1916,  carried 
by  the  War  Revenue  Act,  specifically  provides  that  a  stock  dividend 
shall  be  regarded  as  income  to  the  stockholders  to  whom  the  distri- 
bution is  made,  the  same  as  a  cash  dividend.  Prior  to  such  amend- 
ment a  stock  dividend  was  returnable  at  its  "cash  value"  and  there 
was  a  great  deal  of  controversy  over  the  Department's  definition  of 


THE    INCOME   TAX  185 

"cash  value."    Now  the  law  states  that  the  stock  dividend  shall  be  re- 
turned to  the  amount  of  the  earnings  or  profits  so  distributed. 

339.— DIVIDENDS  OUT  OF  SURPLUS— 
FROM  ACCUMULATED  EARNINGS. 

So  involved  is  the  language  of  the  statute  relative  to  the  imposi-, 
tion  of  the  income  tax  upon  income  represented  by  dividends  received 
by  the  shareholder  in  a  corporation  when  the  corporation  has  de- 
clared and  paid  such  dividends  out  of  surplus,  the  subject  must  be 
gone  into  in  detail.  But  the  administration  of  the  law  in  this  respect 
is  bound  to  be  complicated  and,  in  a  sense,  arbitrary,  and  that  numer- 
ous controversies  will  result  is  certain. 

The  question  is  one  of  the  utmost  importance  to  the  shareholder 
in  a  corporation,  in  view  of  the  fact  that  dividends  in  the  hands  of  an 
individual  are  subject  to  the  high  percentages  of  the  additional  tax 
under  both  the  old  and  the  new  income  tax  laws. 

First,  in  order  that  the  statute  may  be  read  in  connection  with  an 
interpretation  of  its  meaning,  the  new  section  added  by  one  of  the 
amendments  carried  by  the  Act  of  October  3,  1917  is  quoted  as 
follows  : 

Sec.  31.  (a)  That  the  term  "dividends"  as  used  in  this  title  shall 
be  held  to  mean  any  distribution  made  or  ordered  to  be  made  by  a  cor- 
poration, joint-stock  company,  association,  or  insurance  company,  out 
of  its  earnings  or  profits  accrued  since  March  1,  1913,  and  payable  to 
its  shareholders,  whether  in  cash  or  in  stock  of  the  corporation,  joint- 
stock  company,  association,  or  insurance  company,  which  stock  divi- 
dend shall  be  considered  income,  to  the  amount  of  the  earnings  or 
profits  so  distributed. 

(b)  Any  distribution  made  to  the  shareholders  or  members  of  a 
corporation,  joint-stock  company,  or  association,  or  insurance  company, 
in  the  year  1917,  or  subsequent  tax  years,  shall  be  deemed  to  have  been 
made  from  the  most  recently  accumulated  undivided  profits  or  surplus, 
and  shall  constitute  a  part  of  the  annual  income  of  the  distributee  for 
the  year  in  which  received,  and  shall  be  taxed  to  the  distributee  at  the 
rates  prescribed  by  law  for  the  years  in  which  such  profits  or  surplus 
were  accumulated  by  the  corporation,  joint-stock  company,  association, 
or  insurance  company,  but  nothing  herein  shall  be  construed  as  taxing 
any  earnings  or  profits  accrued  prior  to  March  1.  1913,  but  such  earn- 
ings or  profits  may  be  distributed  in  stock  dividends  or  otherwise, 
exempt  from  the  tax,  after  the  distribution  of  earnings  and  profits  ac- 
crued since  March  1,  1913,  has  been  made.  This  subdivision  shall  not 
apply  to  any  distribution  made  prior  to  August  6,  1917,  out  of  earnings 
or  profits  accrued  prior  to  March  1,  1913. 

Such  is  the  law.  It  had  not  been  interpreted  by  the  Treasury  De- 
partment when  this  book  went  to  press.  No  doubt  it  will  be  given  a 
general  official  interpretation,  but  even  then,  many  controversies  will 
arise  when  administration  threatens  to  work  inequity  in  individual 
cases,  and.  as  with  the  interpretation  of  so  many  other  requirements 


186  THE    INCOME   TAX 

of  the  law,  special  attention  and  consideration  will  have  to  be  given 
to  individual  cases. 

This  tentative  and  unofficial  interpretation  is  given,  subject  to 
correction  later  to  be  made  by  supplement  or  letter,  if  necessary,  after 
the  Department  has  stated  its  understanding  of  the  statute  and  indi- 
cated its  procedure. 

There  are  four  basic  considerations  to  be  kept  in  mind  whenever 
the  taxability  of  income  as  represented  by  a  dividend  is  in  question : 

(1)  That  part  of  an  individual's  income  represented  by  a  dividend 
from  a  corporation  is  not,  in  any  circumstances,  subject  to  the  normal 
tax.     It  is  subject  to  the  additional  tax  when  it  forms  part  of  a  total 
net  income  sufficiently  large,  as  a  whole,  to  be  subject  to  additional 
tax.     (For  the  year  1917  and  subsequent  years,  in  excess  of  $5,000;  for 
the  years  1913,  1914,  1915  and  1916,  in  excess  of  $20,000). 

(2)  The  entire  amount  of  income  represented  by  dividends,  re- 
ceived by  one  corporation  from  stock  owned  in  another  corporation, 
is  subject  to  tax  in  the  hands  of  the  recipient  corporation  in  the  com- 
putation of  tax  liability  under  the  Act  of  September  8,  1916  (the  old 
income  tax  law)  for  all  years  beginning  with  the  year  1913. 

(3)  The  entire  amount  of  income  represented  by  dividends,  re- 
ceived by  one  corporation  from  stock  owned  in  another  corporation, 
is  allowed  as  a  deduction  and,  therefore,  is  not  subject  to  tax  in  the 
hands  of  the  recipient  corporation  in  the  computation  of  tax  liability 
under  the  Act  of  October  3.  1917  (new   or   War  income  tax  law)  for 
the  year  1917  and  subsequent  years. 

(4)  Both  income  tax  laws  (Act  of  September  8,  1916  and  Act  of 
October  3,  1917)  are  in  effect  and  the  different  requirements    of    the 
two  with  respect  to  income  represented  by  dividends  received  by  one 
corporation  from  stock  owned  in  another  corporation  must  be  com- 
plied with  in  the  computation  of  a  corporation's  total  income  tax  lia- 
bility. 

With  the  above  considerations  in  mind  the  provisions  of  Section 
31.  added  to  the  Act  of  September  8,  1916  by  the  War  Revenue  Act 
and  quoted  above,  seem  capable  of  being  stated  as  follows  : 

(1)  A  dividend,  received  by  either  an  individual  or  a  corporation, 
is  taxable  only  when  it  represents  a  distribution  of  earnings  or  profits 
accrued  to  or  earned  by  the  distributing  corporation  since  March  1, 
1913. 


THE    INCOME    TAX  187 

(2)  If  a  dividend  is  taxable  in  the  hands  of  the  recipient,  either 
an  individual  or  a  corporation,  the  form  or  medium  of  payment  makes 
no  difference.     It  can  be  in  either  cash  or  stock,  or  otherwise,  with  a 
stock  dividend  to  be  accounted  for  to  the  amount  of  the  earnings  or 
profits  so  distributed  by  the  distributing  corporation. 

(3)  The  presumption  of  the  law  is  that  a  dividend  is  paid  out  of 
the  most  recently  accumulated  undivided  profits  or  surplus ;  that  is,  a 
dividend  out  of  undivided  profits  or  surplus  must  first  be  considered 
as  distributing  the  earnings  accumulated  in  the  years  since  March  1, 
1913  before  it  can  be  regarded  as  drawing  upon  earnings  accumulated 
prior  to  March  1,  1913.    If  such  dividend  is  in  excess  of  the  additions 
to  surplus  since  March  1,  1913,  the  amount  by  which  it  exceeds  such 
additions,  and  only  such  amount,   is   to   be   considered  as  paid  out  of 
earnings  accrued    to    the    distributing  corporation  prior  to  March  1, 
1913  and,  therefore,  as  not  taxable  to  the  recipient.    If  a  dividend  paid 
out  of  undivided  profits  or  surplus    does    not    exceed    additions  since 
March  1,  1913,  the  entire  amount  of  it  is  taxable  to.  the  recipient. 

(4)  A  dividend  paid  out  of  undivided  profits    or    surplus — when 
out  of  earnings  accrued  since  March  1,  1913 — may  be  out  of  earnings 
accumulated  in  more  than  one  year.     Rut  it  must  be  included  by  the 
recipient  individual  or  corporation  in  the  return  for  the  year  in  which 
received,  although  to  the  particular  part  of  such  dividend  definitely 
representing  a  distribution  of  earnings    of    a    particular  year  will  be 
applied  the  tax  rate  or  rates  provided  by  law  for  that  year. 

(5)  The  law  contains  an  exception  with  respect  to  any  distribu- 
tion made  prior  to  August  6,  1917,  the  date  when  the  amended  income 
tax  law  was  reported  in  the  Senate.    Under  the  law  and  regulations 
in  effect  then  a  corporation  could  designate  its  accumulated  earnings 
accrued  prior  to  March  1,  1913  as  the    earnings    distributed   and   the 
dividend  was  exempt  from  tax  to  the  shareholders.    The  exception  in 
the  present  law  respects  any  such  designation,  and  the  amount  of  any 
dividend  with  its  identity  thus  "branded"  remains  exempt  from  tax, 
in  the  case  of  a  distribution  prior  to  August  6,  1917. 

In  paragraph  No.  4  above  the  statement  has  been  made  that  it 
may  occur  that  a  dividend  included  in  a  return  for  the  year  when  re- 
ceived may  be  subject  to  tax  under  the  rates  applicable  to  one  or  more 
other  years — the  year  or  years  when  there  accrued  the  earnings  dis- 
tributed by  it.  The  rates  for  the  year  1917  and  subsequent  years  ap- 
pear elsewhere  in  this  book.  The  only  rates  of  tax  in  effect  in  other 


188 


THE    INCOME   TAX 


years  to  which  any  such  dividend  could  be  subject  are  as  follows  : 

Rates  of  1913,  1914  and  1915. 
Individuals. 

Only  to  additional  tax  as  follows : 

Income  between  $  20,000  and  $  50,000 1  per  cent 

$  50,000   "    $  75,000   2    "     " 

$  75,000    "    $100,000   .....3    "      " 

$100,000    "    $250,000   4    "      " 

$250,000    "    $500,000 5    "      " 

above    $500,000    6    "      " 

Corporations. 

The  flat  rate  of  1  per  cent  upon  the  entire  amount. 


Rates  of  1916. 
Individuals. 

Only  to  additional  tax  as  follows  : 

Income  between  $     20,000  and  $     40,000 1  per 

$     40,000     "   $     60,000    2  " 

$     60,000     "   $     80,000 3  " 

$     80,000     "   $    100,000    4  " 

$    100,000    "   $    150,000    5  " 

$    150,000    "   $   200,000    6  " 

$   200,000    "   $   250,000    7  " 

$   250,000    "   $    300,000    8  " 

$    300,000    "   $   500,000    9  " 

$   500,000     "   $1,000,000     10  " 

$1,000,000    "   $1,500,000    11  " 

$1,500,000     "   $2,000,000    12  " 

above     $2,000,000  13  " 

Corporations. 

The  flat  rate  of  2  per  cent  upon  the  entire  amount. 


cent 


To  illustrate  the  above  interpretation  of  the  law  : 

Suppose  a  corporation,  to  be  known  in  this  example  as  the  Cali- 
fornia Fruit  Company,  had  on  March  1.  1913  a  surplus  of  $1,000,000. 
In  the  year  1914  it  added  $200.000,  in  the  year  1915  $200,000  and  in  the 


THE    INCOME   TAX  189 

year  1916  $100,000.  Thus,  on  January,  1,  1917  the  surplus  of  the  com- 
pany stood  at  $1,500,000.  In  the  year  1917  subsequent  to  August  6, 
the  company  declares  a  dividend  of  $1,000,000,  to  be  paid  out  of  sur- 
plus. 

Does  the  dividend  out  of  surplus  represent  the  earnings  of  the 
company  prior  to  March  1,  1913,  in  view  of  the  fact  that  on  March  1, 

1913  there  was  a  surplus  equal  to  the  amount  of  the  dividend  declared 
and  paid  in  1917,  or  must  the  additions  to  surplus  since  March  1,  1913 
and  prior  to  the  declaration  and  payment  of  the  dividend  be  taken  into 
consideration  in  determining   the   taxability   of   the    dividend    in   the 
hands  of  the  recipient  shareholders  ? 

The  presumption  of  the  law  is  that  the  dividend  is  paid  out  of  the 
most  recently  accumulated  surplus.  Therefore,  the  additions  to  sur- 
plus in  the  years  1914,  1915  and  1916,  totaling  for  those  three  years 
$500,000,  must  be  regarded  as  distributed  by  the  dividend,  with  the  re- 
maining $500,000  of  the  dividend  coming  out  of  surplus  from  earnings 
prior  to  March  1,  1913.  And  so  one-half  of  the  dividend  is  taxable  to 
the  shareholders. 

John  Smith  owns  100  shares  of  the  stock  of  the  California  Fruit 
Company  and  he  receives  in  the  year  1917,  when  the  dividend  is  paid 
out  of  surplus,  $300  a  share,  or  $30,000  in  all.  From  other  sources  he 
has  a  net  income  for  the  year  1917  amounting  to  $25,000.  How  must 
he  treat  the  dividend  of  $30,000  in  making  return  to  the  Government 
and  how  is  it  subject  to  tax? 

Only  one-half  of  the  $30,000,  or  $15,000,  need  be  returned  as  tax- 
able income  because,  as  shown  above,  only  one-half  of  the  dividend 
has  been  paid  out  of  thp  earnings  of  the  corporation  since  March  1. 
1913. 

And  the  amount  of  $15,000  is  not  subject  to  tax  at  the  1917  rates. 
An  amount  equal  to  two-fifths  of  it,  or  $6,000,  belongs  to  the  year 

1914  and  is  taxable  according  to  the  rates  then  in  effect ;  two-fifths,  or 
$6,000,  to  the  year  1915,  taxable  at  that  year's  rates;  and  the  remain- 
ing one-fifth,  or  $3,000,  to  the  year  1916,  taxable  at  that  year's  rates. 

Smith's  liability  to  tax  upon  his  1917  income  is  computed  upon  the 
$25,000  net  income  from  other  sources  and  at  the  1917  rates.  Then 
$6,000  is  added  to  the  $25,000  and  tax  is  computed  for  the  year  1914 
upon  the  $6,000,  according  to  the  additional  tax  rate  of  1  per  cent  ap- 
plicable to  income  between  $20,000  and  $50,000,  the  tax  being  $60. 
Next  the  same  method  is  followed  with  respect  to  the  two-fifths  of 
the  dividend  belonging  to  the  year  1915,  and  the  tax  rates  for  that 
year  being  the  same  as  in  the  year  1914,  the  amount  of  tax  found  to  be 


190  THE    INCOME   TAX 

due  is  the  same,  or  $60.  And  then  the  amount  of  $3,000  is  added  to 
the  $25,000  and  tax  is  computed  for  the  year  1916  upon  the  $3,000  ac- 
cording to  the  additional  rate  of  1  per  cent  then  applicable  to  income 
between  $20,000  and  $40,000,  the  tax  being  $30.  The  total  tax  upon 
the  $15,000  would  be  $150. 

In  the  example  just  given  the  1  per  cent  additional  rate  happened 
to  be  applicable  in  the  computation  under  each  year's  schedule.  But 
the  reader  can  see  howr,  were  the  amount  of  the  dividend  larger,  the 
addition  of  the  amount  of  it  apportioned  to  each  of  the  three  years  to 
the  net  income  from  other  sources  (the  $25,000)  might  result  in 
assessment  according  to  different  additional  rates  in  different  years. 

Suppose  another  stockholder  of  the  California  Fruit  Company  is 
the  California  Warehouse  Company.  This  corporation  stockholder 
also  receives  $30,000  of  the  dividend  paid  out  of  surplus  by  the  Cali- 
fornia Fruit  Company  in  the  year  1917.  Of  the  amount  only  $15,000  is 
subject  to  tax  as  follows :  $6,000  for  the  year  1914  at  the  flat  rate  of  1 
per  cent — tax  $60;  and  $6,000  for  the  year  1915  at  1  per  cent — tax  $60; 
and  $3,000  for  the  year  1916  at  the  flat  rate  of  2  per  cent— tax  $60; 
total  tax  upon  the  $15,000— $180. 

Again,  if  the  dividend  of  $1,000,000  had  been  declared  and  paid  by 
the  California  Fruit  Company  prior  to  August  6,  1917  and  if  the  com- 
pany had  provided  by  the  proper  action  of  its  directors  that  such  divi- 
dend was  to  be  paid  out  of  surplus  earned  prior  to  March  1,  1913,  the 
Government  would  be  obliged  to  respect  the  action  of  the  company 
and  no  part  of  the  dividend  would  be  subject  to  tax  in  the  hands  of  the 
shareholders.  Neither  Smith  nor  the  California  Warehouse  Company 
would  have  to  account  for  any  part  of  the  $30,000  received  by  each. 

340.— ACCOUNTS  RECEIVABLE 
MAY  BE  INCLUDED. 

While  the  income  tax  law  imposes  a  tax  upon  "income  received," 
it  also  provides  for  return  upon  any  other  basis  than  that  of  actual  re- 
ceipts and  disbursements  for  the  year.  Three  years  of  experience  in 
administering  the  law  proved  that  its  administration  must  run  along 
the  lines  of  customary  business  procedure  provided  such  concession 
to  business  procedure  does  not  allow  evasion  of  tax.  Consequently 
accounts  receivable  in  the  case  of  a  business  with  outstanding  and  un- 
collected  accounts  at  the  end  of  the  year  may  be  treated  as  though 
they  had  been  collected.  The  amounts  represented  by  them  may 
be  regarded  as  having  been  received  in  striking  the  balance  on  the 
year's  business. 


THE    INCOME   TAX  191 

Often,  of  course,  accounts  receivable  are  not  received.  Any 
amount  represented  by  an  uncollectible  account,  which  has  been  in- 
cluded as  income,  can  subsequently  be  charged  off  as  a  bad  debt  in  the 
return  for  the  year  in  which  it  is  ascertained  to  be  uncollectible  ;  but 
it  must  be  charged  against  the  income  of  the  year  in  which  the  account 
is  found  to  be  worthless.  If  it  should  happen  that  the  gross  income 
for  that  year  were  not  sufficient  to  cover  losses  due  to  accounts  previ- 
ously returned  as  income  and  in  that  year  ascertained  to  be  uncollecti- 
ble, the  taxpayer  would  not  appear  to  have  any  means  of  recovering 
the  amount  of  tax  paid  upon  income  represented  by  such  accounts. 

341.— INCOME   FROM   MERCANTILE   BUSINESS. 

The  general  rule  which  in  its  regulations,  decisions  and  corres- 
pondence the  Department  has  provided  for  ascertaining  the  income  of 
a  mercantile  business  is  as  follows  : 

The  inventory  of  stock,  taken  at  the  beginning  of  the  year  (or 
more  generally  at  the  close  of  the  preceding  year)  should  be  added  to 
the  purchases  during  the  year  for  which  the  return  is  made.  This 
total  represents  what  the  merchant  has  put  into  his  business.  Then 
the  sales  during  the  year  should  be  added  to  the  inventory  taken  at 
the  close  of  the  year,  the  sum  standing  for  what  has  come  out  of  the 
business  during  the  year.  The  difference  between  the  two  totals 
represents  the  merchant's  gross  income  for  the  year,  provided  the 
sum  of  sales  and  closing  inventory  be  in  excess  of  the  sum  of  opening 
inventory  and  purchases.  The  amount  of  gross  income  thus  ascer- 
tained should  be  entered  as  such.  This  is  not  the  amount,  however, 
which  is  subject  to  tax,  for  the  merchant  is  allowed  the  usual  deduc- 
tions. On  the  opposite  side  of  his  return  he  can  deduct  all  the  neces- 
sary and  ordinary  expenses  of  his  business  such  as  cost  of  labor,  fuel, 
rent,  etc.,  and  allowances  for  interest,  taxes  and  losses  within  the 
limits  imposed  by  statute. 

The  opening  and  closing  inventories  should  be  on  the  same  basis, 
whether  at  cost  or  otherwise. 

342.— ROYALTIES   FROM   MINES   AND  WELLS. 

The  income  that  comes  from  the  leasing  of  a  mine  or  an  oil  or 
gas  well  in  the  form  of  a  royalty  paid  by  the  lessee,  according  to  pro- 
duction, must  be  returned  by  the  lessor  recipient  for  tax.  There  have 
been  numerous  controversies  between  the  Government  and  the  own- 
ers of  ore,  oil  and  gas  properties  on  this  point,  the  owners  having  con- 


]Q2  THE    INCOME    TAX 

tended  that  the  process  of  mining  ore  or  producing  oil  or  gas  repre- 
sents merely  a  conversion  of  capital  The  requirement  is,  however, 
that  the  lessor  account  for  such  royalties  as  a  part  of  gross  income 
and  then  avail  himself  of  the  privilege  to  claim  against  his  income 
from  royalties  deduction  for  loss  on  account  of  the  exhaustion  of  his 
ore  deposits  or  the  reduction  in  flow  from  his  oil  and  gas  properties. 

343.— HOW  A  CORPORATION  CAN  GET 

BENEFIT  OF  INTEREST  DEDUCTION. 

As  explained  in  reference  to  the  deductions  allowed  a  corporation, 
the  deduction  on  account  of  interest  paid  during  the  year  is  limited  to 
the  interest  paid  upon  an  indebtedness  equal  to  the  sum  of  the  paid  up 
capital  stock  of  the  corporation  and  one-half  of  its  interest-bearing 
indebtedness  outstanding  at  the  close  of  the  year.  Thus  an  arbitrary 
maximum  principal  has  been  fixed  by  law  and  the  problem  is  how  to 
take  full  advantage  of  it,  as  every  corporation  has  a  right  to  do. 

The  limitation  as  to  principal  is  not  to  be  interpreted  as  meaning 
that  interest  paid  during  the  year  cannot  be  deducted  at  all  unless  the 
indebtedness  on  which  it  has  been  paid  remains  outstanding  at  the 
close  of  the  year.  Such  interest  can  be  deducted,  regardless  of  when 
during  the  year  the  indebtedness  on  which  it  is  paid  is  disposed  of, 
provided  the  amount  of  the  indebtedness  be  taken  into  consideration 
with  respect  to  the  limitation  upon  principal  above  noted.  Tt  is  prob- 
ably best  to  illustrate  : 

The  West  Realty  &  Investment  Company  (so  named  for  this  ex- 
ample) has  at  the  close  of  the  year  1917  a  paid-up  capital  stock  out- 
standing of  $100,000.  Its  interest-bearing  indebtedness  at  the  close 
of  the  year  is  $300,000.  To  determine  the  maximum  principal  for  the 
purpose  of  ascertaining  its  possible  interest  deduction  it  would  add  to 
the  amount  of  $100,000  (paid-up  capital  stock)  one-half  of  $300.000 
(interest-bearing  indebtedness  outstanding  at  the  close  of  the  year). 
The  sum  would  be  $250,000,  the  maximum  principal. 

The  company's  indebtedness,  above  referred  to,  consists  of  the 
following  items  :  a  bond  issue  of  $100,000  at  5  per  cent ;  bank  loans 
aggregating  $60,000  at  6  per  cent ;  owing  under  a  mortgage  upon  a 
building  it  has  constructed  $90,000  at  7  per  cent ;  owing  upon  various 
notes  for  short-term  loans  $50.000  at  8  per  cent.  Thus  its  indebted- 
ness stands  at  the  close  of  the  year.  However,  other  short-term  notes 
to  the  amount  of  $40,000  having  become  due  on  December  1,  it  has 
paid  them  and  interest  upon  them  for  the  last  year  at  8  per  cent. 


THE    INCOME   TAX 


193 


How  can  the  company  arrive  at  its  maximum  deduction  for  in- 
terest? 

Assuming  that  the  company  has  paid  the  interest  upon  its  obliga- 
tions, it  can  proceed  in  the  computation  as  follows : 

Principal  Maximum 

Used  Principal 


First  take  indebtedness  on  which 
highest  rate  of  interest  is  paid,  which 
consists  of  short-term  notes  outstand- 
ing of  $50,000  and  those  paid  Dec.  1  of 
$40,000,  both  at  8  per  cent $90,000 

Next  take  amount  on  which  next 
highest  rate  is  paid,  which  is  amount 
due  under  mortgage  on  building  for 
$90,000  at  7  per  cent $90.000 

Next  take  bank  loans  on  which 
third  rate  of  interest  (working  scale 
downward)  is  paid,  which  is  the  $60,000 
at  6  per  cent $60,000 

Having  now  used  $240,000  of  the 
maximum  principal,  only  $10,000  of  the 
$100,000  bond  issue  can  be  taken,  at 
5  per  cent ....$10,000 


$250,000 


Total  $250,000  $250.000 

There  then  remains  $90,000  of  the  bond  issue  at  5  per  cent,  upon 
which  interest  has  been  paid  but  for  which  payment  no  deduction  can 
be  claimed.  It  is  obviously  better,  however,  that  the  indebtedness 
"left  over"  in  excess  of  the  statutory  limit  be  that  on  which  5  per  cent 
has  been  paid  than  it  be  indebtedness  on  which  one  of  the  higher  rates 
has  been  paid.  The  law's  limitation  has  nothing  to  do  with  the  rate  of 
interest  paid :  it  applies  only  to  the  fixing  arbitrarily  of  a  maximum 
principal. 

An  extreme  example  has  been  given,  but  deliberately  so,  in  order 
to  emphasize  the  illustration. 

344.— CARRYING  CHARGES  AS 

PART  OF  PROPERTY  COST. 

In  ascertaining  gain  or  loss  from  the  sale  or  disposition  of  prop- 
erty when  cost  is  the  basis  of  computation  it  is  proper  to  add  to  thv 


194  THE    INCOME   TAX 

original  purchase  price  certain  expenses  incident  to  the  purchase, 
holding  and  sale  of  the  property  in  order  that  its  actual  cost  may  be 
determined.  In  this  respect  it  should  be  understood,  however,  that 
the  Government  will  now  allow  any  item  of  expense  to  be  added  which 
the  owner  of  the  property  has  covered  by  a  deduction  in  a  previous 
return  of  income.  In  other  words,  incidental  expenses  or  carrying 
charges  cannot  be  added  to  the  original  purchase  price  for  the  purpose 
of  reducing  the  amount  of  gain  to  be  returned  for  taxation  or  for  the 
purpose  of  increasing  the  amount  of  loss  to  be  deducted,  if  such  inci- 
dental expenses  and  carrying  charges  were  deducted  in  returns  made 
for  the  years  in  which  incurred. 

345.— PROPERTY  EXCHANGED 

WITHOUT  CASH  VALUATION. 

The  exchange  of  property  when  there  is  no  cash  valuation  can  be 
regarded  as  a  mere  change  of  assets  that  need  not  be  accounted  for 
in  a  return  of  income.  It  is  only  when  the  exchange  is  on  a  cash 
basis,  where  a  definite  valuation  is  made  of  the  properties  exchanged, 
that  there  is  a  closed  transaction  and  a  realization  of  income  or  loss. 
When  the  exchange  is  not  on  such  a  cash  basis  and  the  property  re- 
ceived in  exchange  is  later  sold,  the  amount  of  gain  or  loss  must  be 
determined  by  going  back  to  the  cost  of  the  property  given  in  ex- 
change for  it. 

346.— SALE  OF  REAL  ESTATE 
ON  INSTALLMENTS. 

With  respect  to  accounting  for  the  profit  derived  from  the  sale  of 
real  estate  on  the  installment  plan,  the  Treasury  Department  has  re- 
peatedly changed  its  position.  The  latest  ruling  is  that  each  payment, 
when  received,  should  be  apportioned  between  a  return  of  the  cost  of 
the  property  and  profit.  In  other  words,  the  Department  takes  the 
position  that  each  installment  payment  received  under  the  contract 
represents  in  part,  return  of  the  cost,  and  in  part,  profit ;  and  that  the 
profit  for  a  year  may  be  thus  ascertained. 

Prior  to  the  issuance  of  the  above  ruling  it  was  the  practice  of  the 
Department,  where  title  does  not  pass  until  the  final  installment  is 
paid,  to  hold  that  the  running  installment  payments  on  account  of  the 
purchase  price  are  merely  cash  receipts  and  do  not  ordinarily  repre- 
sent income  for  the  year  in  which  received.  In  other  words,  the  sale 
was  regarded  as  having  been  completed  when  the  final  installment  is 


THE   INCOME   TAX 

paid  and  title  passes,  and  then  the  gain  from  the  transaction  can  be 
ascertained  and  returned  as  income  for  the  year  in  which  the  final  in- 
stallment is  paid. 

In  some  cases  the  dealer  has  accounted  for  the  gain  represented 
by  a  transaction  of  this  kind  as  of  the  year  in  which  the  contract  of 
sale  is  made  and,  in  the  event  of  the  contract  becoming  void  prior  to 
payment  of  the  final  installment,  has  claimed  allowance  for  any  loss 
sustained  by  default  on  the  part  of  the  vendee  and  consequent  lapse  of 
contract,  taking  into  consideration  the  recovery  of  the  property. 

When  an  installment  payment,  monthly,  annual  or  for  some  other 
fixed  period,  represents  not  only  payment  on  account  of  the  principal 
of  the  purchase  price,  but  also  interest  on  deferred  payments,  the 
amount  of  it  representing  interest  should  be  returned  as  income  for 
the  year  in  which  received. 

347.— RETURN  CAN  BE  SWORN  TO 

BEFORE  ARMY  AND  NAVY  OFFICERS. 

Persons  in  the  Military  or  Naval  service  of  the  United  States, 
wherever  they  may  be  stationed,  can  sign  and  swear  to  their  returns 
of  income  before  officers  of  the  Army  or  Navy  who  are  authorized  to 
administer  oaths  for  the  purpose  of  Military  and  Naval  justice  and  ad- 
ministration. 

348.— NON-RESIDENT  ALIEN 
HAS  NO  EXEMPTION. 

A  non-resident  alien  individual  is  not  entitled  to  the  specific  ex- 
emption allowed  a  citizen  or  resident  of  the  United  States.  He  can  not 
claim  the  benefit  of  a  credit  of  either  $3,000  or  $4,000  in  making  his  re- 
turn of  income  from  sources  in  the  United  States. 

349.— LIFE   INSURANCE  IN  FAVOR 
OF  FIRM  OR  CORPORATION. 

One  of  t'he  income  tax  amendments  carried  by  the  Act  of  October 
3,  1917  is  to  the  effect  that  premiums  paid  on  life  insurance  policies 
covering  the  lives  of  officers  or  employees  or  members  of  a  corpora- 
tion or  partnership  can  not  be  deducted  by  a  corporation  in  its  return 
of  income  or  by  a  partnership  in  computing  its  net  earnings  in  order 
that  each  partner  may  include  his  share  of  such  net  earnings  in  his  in- 
'dividual  return. 


196  THE    INCOME   TAX 


CHAPTER  XXI 


THE  INCOME  TAX 


ASSESSMENT  AND  PAYMENT 
OF   INCOME  TAX 


350.— RETURNS  CHECKED  BY  COLLECTOR. 

Returns  of  income  of  individuals  and  corporations  and  withhold- 
ing agents  having  been  filed  within  the  time  prescribed  by  law  (on  or 
before  March  1  or  within  60  days  after  the  close  of  a  corporation's 
fiscal  year)  they  are  checked  by  the  deputies  and  clerks  in  the  office 
of  the  Collector.  In  other  words,  the  first  audit  is  in  the  office  of  the 
Collector.  The  returns  which  pass  this  audit  are  listed  on  assess- 
ment lists  and  forwarded  to  the  Commissioner  of  Internal  Revenue  at 
Washington,  D.  C.  The  returns  which  do  not  pass  this  audit  are  re- 
turned to  the  taxpayer  for  correction,  and,  when  so  returned,  should 
be  accompanied  by  specific  instructions  and  reasons  for  the  change 
demanded  by  the  Collector.  When  again  sent  to  the  Collector,  the 
amended  or  corrected  return  is  listed  for  assessment  and  sent  to 
Washington. 

351.— SENT  TO  WASHINGTON. 

A  Collector  retains  in  his  office  only  a  partial  card  record  contain 
ing  only  a  few  of  the  facts  disclosed  by  a  return  of  income.  All  re- 
turns remain  permanently  in  the  office  of  the  Commissioner  of  In- 
ternal Revenue  at  Washington.  It  is  not  possible,  therefore,  for  a 
Collector  to  comply  with  a  request  for  a  copy  of  a  return  after  the  re- 
turn has  been  forwarded  to  Washington.  Such  request  should  be 
made  directly  to  the  Commissioner  at  Washington  and  will  be  com- 
plied with  only  when  made  by  the  taxpayer  (individual  or  corpora- 
tion) or  the  taxpayer's  duly  authorized  attorney  or  representative. 


THE   INCOME   TAX  197 

352.— ASSESSED  BY  COMMISSIONER. 

The  tax  is  assessed  by  the  Commissioner  and  the  assessment  list 
is  returned  to  the  office  of  the  Collector.  The  Collector  then  issues  to 
each  taxpayer  a  notice  of  assessment. 

353.— TIME  OF   NOTIFICATION. 

The  law  requires  that  each  taxpayer  receive  notice  of  the  amount 
of  tax  due  on  or  before  the  first  day  of  June  (that  is,  on  or  before  June 
1,  1918  for  tax  due  on  income  for  the  year  1917,  and  so  on  in  subse-/ 
quent  years)  or,  in  the  case  of  a  corporation  filing  return  on  the  basis 
of  a  fiscal  year,  on  or  before  the  expiration  of  90  days  from  the  date 
when  the  return  is  required  to  be  filed.  (As  the  return  in  such  a  case 
must  be  filed  within  60  days  after  the  close  of  the  fiscal  year,  it  fol- 
lows that  notice  of  tax  due,  must  be  given  the  corporation  not  later 
than  150  days  after  the  close  of  the  fiscal  year.) 

However,  as  the  filing  of  returns  begins  immediately  after  Janu- 
ary 1  and  as  such  returns  are  sent  to  Washington  for  assessment  and 
received  back  as  rapidly  as  they  can  be  handled,  notice  of  amount  of 
tax  due  may  reach  the  taxpayer  long  before  June  1  or  the  expiration 
of  150  days  after  the  close  of  a  fiscal  year.  Payment  need  not  be 
made,  however,  at  the  time  of  such  early  receipt  of  notice.  The  tax- 
payer has  the  right  to  defer  payment  for  as  long  a  time  as  the  law 
allows  him — which  time  is  stated  in  the  notice. 

354.— TIME  OF  PAYMENT. 

The  law  requires  that  the  tax  be  paid  on  or  before  June  15,  in  the 

case  of  returns  regularly  filed  for  the  preceding  calendar  year. 

With  respect  to  the  return  filed  by  a  corporation  upon  the  basis 
of  its  own  fiscal  year,  the  law  requires  that  the  tax  be  paid  within  105 
days  after  the  date  on  which  the  return  is  required  to  be  filed.  As  a 
return  in  such  circumstances  must  be  filed  not  later  than  60  days  after 
the  close  of  the  fiscal  year,  it  follows  that  the  tax  must  be  paid  not 
later  than  165  days  after  the  close  of  the  fiscal  year. 

When  additional  assessment  is  made  by  the  Commissioner  of  In- 
ternal Revenue  as  a  result  of  a  subsequent  investigation  of  a  return, 
the  Collector  issues  a  peremptory  ten-day  demand  for  payment  of  the 
tax. 

355.— WHEN  DELINQUENT. 

But  the  penalty  for  delinquency  in  payment  does  not  attach  the 
next  day  after  June  15  or  the  next  day  after  the  end  of  the  165-day 
period  following  the  close  of  a  corporation's  fiscal  year. 


198  THE    INCOME   TAX 

To  any  individual  or  corporation  whose  tax  has  not  been  paid  on 
June  16,  or  on  the  166th  day  after  the  close  of  a  corporation's  fiscal 
year,  the  Collector  issues  a  peremptory  demand  for  payment  within 
10  days. 

If  the  tax  is  not  paid  within  10  days  of  the  date  of  this  notice,  the 
penalty  for  delinquency  attaches,  but  not  before. 

356.— PENALTY  FOR  DELINQUENCY. 

The  penalty  for  delinquency  in  payment  is  5  per  cent  of  the 
amount  of  tax  assessed  and  interest  at  the  rate  of  one  per  cent  a 
month  until  payment  is  made. 

357.— CAN  ENFORCE  COLLECTION. 

But  the  Collector  is  not  obliged  to  await  the  pleasure  of  any  tax- 
payer who  may  choose  to  let  the  5  per  cent  be  added  and  the  interest 
charges  accumulate.  If  the  tax  is  not  paid  within  10  days  of  the  date 
of  his  first  peremptory  notice,  he  is  supposed  to  issue  a  second  10-day 
notice  and,  when  the  time  given  in  such  second  notice  has  expired,  he 
has  the  authority  to  issue  a  Warrant  of  Distraint  and  by  such  warrant 
direct  a  deputy  collector  to  seize  and  sell  sufficient  property  to  satisfy 
the  Government's  claim.  The  Collector  is  given  full  power  in  this  re- 
spect by  the  Revised  Statutes  of  the  United  States.  He  does  not  have 
to  go  into  court  to  seize  and  dispose  of  property. 

358.— NOTICE  BY  MAIL  LEGAL. 

Assessment  notices  are  mailed  by  the  Collector,  and  such  method 
of  notification  has  been  held  to  be  legal  and  the  notice,  when  so  given, 
is  presumed  to  have  reached  the  taxpayer.  The  burden  is  on  the  tax- 
payer to  prove  the  contrary  to  avoid  imposition  of  the  penalty  for  de- 
linquency, according  to  the  Court  in  the  case  of  United  States  v.  Gen- 
eral Inspection  &  Loading  Company  (204  Fed.  657.) 

359.— NO  PENALTY  FOR  ESTATES  OF  INSANE, 
DECEASED  OR  INSOLVENT. 

The  penalty  for  delinquency  in  payment  does  not  attach,  how- 
ever, to  tax  due  from  the  estates  of  insane,  deceased  or  insolvent  per- 
sons. If  a  person  has  regularly  filed  a  return  and  after  having  filed 
such  return  but  before  the  required  date  of  tax  payment  has  become 
insane  or  insolvent  or  has  died,  payment  of  the  tax  assessed  upon  the 
return  filed  does  not  become  delinquent  as  in  the  case  of  other  tax- 
payers. The  Government  collects,  if  possible,  but  only  the  amount  ot 
the  tax  assessed. 


THE   INCOME   TAX  199 

360.— TIME  EXTENDED  FOR  ABSENCE. 

If  an  individual  is  absent  in  a  foreign  country  and  cannot  comply 
with  a  notice  for  payment  of  tax  within  10  days  of  the  date  of  such 
notice,  he  should  retain  the  envelope  in  which  he  receives  the  notice 
and  forward  such  envelope  with  payment  to  the  Collector.  When 
payment  is  made  in  this  way,  the  payment  being  mailed  to  the  Col- 
lector within  10  days  of  date  of  receipt  of  notice  by  the  taxpayer  (as 
shown  by  the  postmark  on  the  envelope),  the  Department  has  held 
that  penalty  for  delinquency  does  not  attach. 

361.— CAN  MAKE  ADVANCE  PAYMENT. 

Payment  of  tax  can  be  made,  if  desired,  at  the  time  of  riling  re- 
turn. That  is.  an  individual  or  a  corporation,  in  forwarding  or  filing 
a  return,  can  remit  or  pay  the  amount  of  tax  shown  by  the  return  as 
prepared.  However,  such  payment  is  taken  by  the  Collector  only  as 
an  "advance  payment."  It  is  conditional  upon  the  correct  amount  of 
tax  being  shown  by  the  return  as  filed.  Later  the  taxpayer  may  re- 
ceive a  demand  for  additional  payment,  or  be  instructed  to  file  claim 
for  refund  of  an  excess  payment. 

362.— CAN  PAY  IN  INSTALLMENTS. 

One  of  the  provisions  of  the  War  Revenue  Act  of  October  3,  1917 
directs  the  Secretary  of  the  Treasury  to  allow  the  advance  payment 
of  income  and  excess  profits  taxes  in  installments  or  in  whole  not  to 
exceed  the  estimated  tax  due.  If  audit  shows  that  the  tax  has  been 
overpaid,  a  refund  is  authorized. 

If  payment  is  made  in  installments, 

(a)  at  least  one-fourth   of   the  estimated  tax  (as  shown  by  the 
return)  must  be  paid  within  30  days  after   the   close   of   the   taxable 
year.     (That  is,  not  later  than  January  30  or  not  later  than   30   days 
after  the  close  of  a  fiscal  year), 

(b)  at  least  a  second  one-fourth  must  be  paid  within  two  months 
after  the  close  of  the  taxable  year,  (explained  above) 

(c)  at  least  a  third  one-fourth  within  four  months  after  the  close 
of  the  taxable  year  (explained  above), 

(d)  and  the  remainder  of  the  tax  due  must  be  paid  on  or  before 
the  time  fixed  by  law  for  payment,  (not  later  than  June  15  or  165  days 
after  the  close  of  a  fiscal  year.) 

Credit  can  be  allowed  by  the  Secretary  of  the  Treasury  in  case  of 
advance  payments  not  to  exceed  3  per  cent  per  annum  calculated  upon 
the  amount  paid  in  advance  from  the  date  of  payment  to  the  date  fixed 


200  THE    INCOME   TAX 

by  law  for  payment  (June  15  or  165  days  after  the  close  of  a  fiscal 
year).  No  such  credit  can  be  allowed,  however,  upon  any  amount  by 
which  an  advance  payment  exceeds  the  tax  found  to  be  due,  or  upon 
any  payment  made  later  than  four  and  a  half  months  after  the  close 
of  the  taxable  year.  (Not  later  than  four  and  a  half  months  after 
December  31  or  after  the  close  of  a  fiscal  year). 

363.— FORM  OF  PAYMENT. 

Payment  may  be  made  in  cash,  or  by  post-office  money  order, 
bank  draft,  cashier's  check  or  certified  check.  The  remittance  must 
be  in  such  form  that  it  can  be  deposited  by  the  Collector  without  ex- 
pense to  the  Government — that  is,  at  par. 

An  uncertified  check  is  accepted  by  a  Collector  conditionally.  It 
does  not  represent  payment  of  a  tax  until  itself  paid  by  the  bank. on 
which  drawn. 

The  War  Revenue  Act  of  October  3,  1917  authorizes  Collectors  to 
accept  also  certificates  of  indebtedness  issued  under  the  Act  of  April 
24,  1917  and  any  subsequent  act.  These  certificates  are  to  be  accepted 
at  par  and  accrued  interest. 

364.— RECEIPTS  FOR  TAXES. 

There  is  just  one  official  receipt  that  a  Collector  can  issue  for  in- 
come tax.  It  is  a  receipt  on  what  is  known  as  Form  1. 

If,  i/i  addition  to  the  official  receipt  on  Form  1,  a  taxpayer  desires 
for  filing  or  in  his  system  of  accounting  a  receipt  on  his  own  form,  or 
an  indorsement  on  his  voucher  check,  the  Collector  is  authorized  to 
comply  with  his  request.  The  Department  has  advised,  however,  that 
in  such  circumstances  the  Collector  should  note  on  the  unofficial  re- 
ceipt the  fact  that  it  is  "not  an  official  receipt." 

If  a  withholding  agent  paying  normal  tax  deducted  at  the  source 
from  income  paid  a  number  of  individuals,  or  corporations,  desires 
from  the  Collector  a  separate  receipt  for  each  individual  or  corpora- 
tion listed  in  his  withholding  return,  the  Collector  must  comply  with 
his  request.  The  law  so  requires. 


THE    INCOME   TAX  201 


CHAPTER  XXII 


THE  INCOME  TAX 

PENALTIES,  OFFER  IN  COMPROMISE 
AND  PROSECUTION 


365.— PENALTIES. 

Severe  penalties  are  provided  in  the  Income  Tax  law  for  failure, 
neglect  or  refusal  to  comply  with  its  provisions.  They  differ  some- 
what as  to  individuals,  corporations  and  withholding  agents. 

Individuals. 

Failure  to  make  return  of  income  at  the  proper  time — a  fine  of 
not  less  than  $20  nor  more  than  $1,000 — and  increase  of  tax  by  50  per 
cent. 

Making  a  false  return — a  fine  not  exceeding  $2,000  or  imprison- 
ment not  exceeding  one  year,  or  both — and  an  increase  of  tax  by  100 
per  cent. 

Corporations 

Failure  to  make  return  of  income  at  the  proper  time — a  fine  not 
exceeding  $10,000 — and  an  increase  of  the  tax  by  50  per  cent. 

Making  a  false  return — a  fine  not  exceeding  $10,000 — and  an 
:ncrease  of  the  tax  by  100  per  cent. 

Also  an  officer  of  a  corporation  charged  by  law  with  the  duty  and 
responsibility  of  making  and  verifying  the  corporation's  return,  who 
makes  a  false  return  with  intent  to  defeat  or  evade  assessment  of  tax, 
is  liable  to  a  fine  not  exceeding  $2,000,  or  to  imprisonment  not  exceed- 
ing one  year,  or  both. 

Collecting  Foreign  Items 
Without  License. 

Any  person,  corporation  or  partnership,  undertaking  as  a  matter 
of  business  or  for  profit  the  collection  of  foreign  interest  or  dividends 


202  THE   INCOME   TAX 

without  having  obtained  a  license  is  liable   to   a   fine   not   exceeding 
$5,000,  or  imprisonment  not  exceeding  one  year,  or  both. 

For  Not  Deducting  Tax 
at  Source. 

Any  person,  corporation,  or  partnership  failing  to  deduct  at  the 
source  the  normal  tax  as  required  by  law  is  liable  to  a  fine  of  not  less 
than  $20  nor  more  than  $1,000. 

Not  Filing  Withholding 
Return  in  Time. 

Any  person,  corporation,  or  partnership  not  filing  return  of  tax 
deducted  at  the  source  in  time  prescribed  by  law  is  liable  to  a  fine  of 
not  less  than  $20  nor  more  than  $1,000 — and  to  an  increase  of  the  tax 
by  50  per  cent. 

Not  Giving  Information 
at  Source. 

Any  person,  corporation  or  partnership  refusing  or  neglecting  to 
supply  information  regarding  payments  to  others,  in  the  form  and 
time  prescribed  is  liable  to  a  fine  of  not  less  than  $20  nor  more  than 
$1,000.  This  includes  brokers  with  respect  to  the  reports  required  of 
them  concerning  their  customers  and  corporations  with  respect  to  the 
reports  required  of  them  concerning  payments  of  dividends. 

Specific  Penalties. 

A  penalty  in  the  form  of  a  fine  is  known  to  the  Treasury  Depart- 
ment as  a  "specific  penalty,"  to  distinguish  it  from  a  penalty  in  the 
form  of  an  increase  of  the  amount  of  tax. 

When  Penalty  Is  Not 
,  Asserted. 

When  a  return  of  income  is  filed  voluntarily  and  without  notice 
from  the  Collector,  the  law  provides  that  the  penalty  for  delinquency 
in  filing  shall  not  be  asserted,  provided  the  taxpayer  can  show  that 
failure  to  file  in  time  was  due  to  a  reasonable  cause  and  not  to  willful 
neglect. 

366.— OFFER  IN  COMPROMISE. 

Section  3229  of  the  Revised  Statutes  of  the  United  States  gives 
the  Commissioner  of  Internal  Revenue,  with  the  advice  and  consent 
of  the  Secretary  of  the  Treasury,  authority  to  compromise  any  civil 


THE    INCOME   TAX  203 

or  criminal  case  arising  under  the  internal  revenue  laws  without  com- 
mencing suit. 

An  offer  in  compromise  may,  therefore,  be  tendered  for  any 
offense  under  the  Income  Tax  law,  as  well  as  under  any  other  internal 
revenue  law. 

Following  is  the  procedure : 

The  taxpayer  who  has  offended  should  first  ascertain  from  the 
office  of  the  Collector  of  Internal  Revenue  the  minimum  amount  to 
which  the  Commissioner  will  give  favorable  consideration.  No  exact 
schedule  of  amounts  can  be  given  here,  although  below  will  be  found 
suggestions  based  upon  experience  in  handling  such  offers. 

Having  fixed  upon  the  amount  to  tender,  the  taxpayer  will 
address  a  letter  (in  duplicate)  to  the  Commissioner  of  Internal  Rev- 
enue at  Washington,  D.  C.  (not  to  the  local  Collector.)  In  this  letter 
the  taxpayer  will  refer  to  the  offense  with  which  he  is  charged  and 
state  that  he  tenders  the  amount  mentioned  in  the  letter  "as  an  offer 
in  compromise  in  lieu  of  all  proceedings,  both  civil  and  criminal.'1 
It  is  important  and  essential  that  the  emphasized  language  just 
quoted  be  used.  It  is  also  necessary  that  at  least  one  copy  of  the 
letter,  be  not  only  signed,  but  also  sworn  to  by  the  taxpayer. 

The  letter  (in  duplicate)  must  then  be  delivered  or  mailed  to  the 
local  Collector  with  the  amount  tendered.  (Note  the  statement  that 
while  the  letter  is  addressed  to  the  Commissioner  it  must  be  delivered 
to  the  local  Collector.) 

The  Collector  will  issue  a  receipt  for  the  amount  tendered  and 
will  forward  the  offer  to  the  Commissioner  at  Washington  for  his 
action.  The  Commissioner  will  thereafter  notify  the  taxpayer  of  his 
acceptance  or  rejection  of  the  offer.  If  he  accepts  the  offer,  the  case 
is  closed;  if  he  rejects  it,  the  taxpayer  may  tender  an  additional  offer, 
following  the  same  course  as  with  the  original  offer. 

Suggestions. 

It  is  known  that  the  following  offers  in  compromise  have  been 
accepted : 

$5  from  individuals  and  withholding  agents  for  delin- 
quency in  filing  returns  of  income. 

$10  from  corporations  for  delinquency  in  filing  returns  of 
income. 

$25  for  refilling  a  bottle  which  has  contained  bottled-in- 
bond  spirits. 


204  THE    INCOME   TAX 

$10  for  refilling  a  cigar  box. 

$10  for  failure  to  stamp   wines   when   the  case  was  not 
aggravated. 

The  above  suggestions  are  not  controlling  but  can  be  followed 
quite  closely,  when  no  intent  to  evade  the  tax  can  be  shown. 

367.— PROSECUTION  OF  OFFENDERS. 

In  all  cases  of  violation  of  internal  revenue  laws  it  is  the  first 
duty  of  the  Collector  to  notify  the  offender  of  his  right  under  Section 
3229  of  the  Revised  Statutes  to  tender  an  offer  in  compromise.  If  an 
offer  is  not  then  made,  it  becomes  the  duty  of  the  Collector  to  report 
the  case  for  prosecution  to  the  United  States  Attorney. 


THE    INCOME   TAX  205 


CHAPTER   XXIII 


CLAIMS 

FOR  ABATEMENT  AND  REFUND 
OF  TAXES 


368.— CLAIM  FOR  REFUND. 

Claim  for  refund  of  any  tax  or  penalty  erroneously  paid  or  col- 
lected can  be  filed  with  the  Collector  under  the  provisions  of  Section 
3220  of  the  Revised  Statutes  of  the  United  States.  Section  22  of  the  In- 
come Tax  law  of  September  8,  1916,  as  amended  by  the  Act  of  Octo- 
ber 3,  1917,  specifically  provides  for  application  of  the  general  law  to 
the  income  tax. 

Claim  for  refund  must  be  filed  on  what  is  known  as  Form  46. 
This  official  form  can  be  obtained  from  the  Collector.  The  taxpayer 
making  the  claim  should  fill  out  only  the  first  page  of  the  claim,  stat- 
ing therein  the  facts  regarding  assessment  and  payment  of  tax  and 
the  reasons  why  the  amount  paid  should  be  refunded. 

The  claim  must  be  sworn  to  by  the  individual  filing  it,  or  by  a 
member  of  a  partnership  or  officer  of  a  corporation.  If  filed  in  behalf 
of  a  partnership  or  corporation,  the  relation  of  the  individual  who 
swears  to  it  to  such  partnership  or  corporation  must  be  plainly  stated. 
The  return  can  be  sworn  to  before  any  officer  qualified  to  administer 
an  oath  or  before  the  Collector  or  a  deputy  collector. 

To  the  claim  should  be  attached  any  evidence  that  can  be  offered 
in  support  of  it.  The  Department  requires  that  the  receipt  for  pay- 
ment of  the  tax  covered  by  the  claim  be  attached. 

After  the  claim  has  been  filed  with  him,  the  Collector,  using  blank 
on  the  second  page,  certifies  it  to  the  Commissioner  at  Washington 
for  consideration.  The  Commissioner  subsequently  gives  notice  of 


206  THE    INCOME   TAX 

his  allowance  or  rejection  of  the  claim.  If  he  allows  it,  a  Treasury 
Warrant  for  the  amount  refunded  is  sent  directly  to  the  claimant 
from  Washington. 

369.— MUST  PRECEDE  SUIT  TO  RECOVER. 

Section  3226  of  the  Revised  Statutes  of  the  United  States  pro- 
vides that  no  suit  for  recovery  of  taxes  can  be  maintained  unless  the 
taxpayer  has  first  appealed  to  the  Commissioner  of  Internal  Revenue 
for  relief.  Such  appeal  takes  the  form  of  a  claim  for  refund.  The 
filing  of  a  claim  is,  therefore,  an  act  essentially  precedent  to  the  main- 
tenance of  a  suit  to  recover  taxes  erroneously  paid  to  the  Govern- 
ment. 

370.— TWO-YEAR  LIMITATION. 

Section  3228  of  the  Revised  Statutes  provides  that  a  claim  for  re- 
fund must  be  filed  within  two  years  after  the  erroneous  collection  of 
the  tax,  if  the  legal  rights  of  the  taxpayer  with  respect  to  subsequent 
suit  for  recovery  of  the  tax  (should  the  claim  be  rejected)  are  to  be 
safeguarded. 

The  date  of  filing  a  claim  with  a  Collector  for  certification  and 
transmission  to  the  Commissioner  is,  therefore,  very  important.  This 
is  the  date  that  shows  whether  the  claimant  is  within  or  without  the 
two-year  limitation.  The  taxpayer  is,  for  this  reason,  advised  to  re- 
quest of  a  Collector,  or  deputy  collector,  a  written  acknowledgment 
of  the  filing  of  a  claim  which  will  show  the  date  of  filing.  Thus  the 
rights  of  the  taxpayer  will  be  protected  should  the  claim  be  delayed 
or  lost  in  transmission. 

371.— EXCEPTIONS  TO  TfTOE  LIMIT. 

While  a  claim  for  refund  of  a  tax  must,  as  a  rule,  be  filed  within 
two  years  after  the  collection  of  the  tax,  pursuant  to  the  provisions  of 
Section  3228,  Revised  Statutes  of  the  United  States,  this  limitation  is 
removed  by  the  last  part  of  subdivision  (a)  of  Section  14  of  the  Act  of 
September  8,  1916,  with  respect  to  claims  for  refund  of  corporation 
excise  tax  paid  under  the  Act  of  August  5,  1909  and  income  tax  paid 
under  the  Act  of  October  3,  1913  and  the  Act  of  September  8,  1916,  if, 
upon  examination  of  a  return  it  is  disclosed  that  tax  was  paid  in  ex- 
cess of  the  amount  due. 

Under  this  provision  claims  once  rejected  because  the  limitation 
as  to  time  had  expired  when  they  were  filed  can  be  reopened,  if  the 
question  at  issue  involves  the  examination  of  a  return. 


THE   INCOME   TAX  207 

372.— CLAIM  TO  COLLECT  JUDGMENT. 

A  claim  for  money  recovered  by  suit  must  likewise  be  filed  on 
Form  46.  The  successful  litigant  should  so  prepare  the  claim  that  it 
will  state  the  names  of  all  parties  to  the  action,  the  cause  of  action, 
date  of  commencement,  date  of  judgment,  court  in  which  recovered 
and  amount  recovered.  To  the  claim  must  be  attached  a  certified 
copy  of  the  record  and  judgment  of  the  court  and  a  receipt  for  all 
costs  from  the  clerk  of  the  court  showing  that  they  have  been  paid  in 
full.  This  claim  should  be  filed  with  the  Collector  against  whom  judg- 
ment has  been  obtained.  It  must  be  sent  by  him  to  Washington  for 
payment.  , 

373.— CLAIM  FOR  ABATEMENT. 

A  claim  for  abatement  of  a  tax  or  penalty  erroneously  assessed 
can  be  filed,  but  prior  to  payment.  Such  claim  is  to  be  prepared  on 
what  is  known  as  Form  47,  to  be  obtained  from  the  Collector  by  re- 
quest. 

This  claim  for  abatement  is  intended,  of  course,  so  to  present  a 
contention  of  error  to  the  Department  that  a  tax  or  penalty  which  has 
been  assessed  will  not  be  collected.  In  it  a  taxpayer  presents  his  side 
of  a  controversy  over  a  disputed  assessment.  It  should  be  prepared 
practically  as  a  claim  for  refund.  (See  instructions  above.) 

374.— IN  PREPARING  FORM  47. 

There  is  a  footnote  on  Form  47  which  would  confuse  any  tax- 
payer without  explanation.  The  footnote  requires  that  "the  substance 
of  Circular  No.  219  should  be  embraced  in  every  affidavit  on  this 
Form,  when  applicable." 

For  the  convenience  of  the  taxpayer  Circular  No.  219  is  herewith 
quoted : 

CIRCULAR  NO.  219. 

Treasury  Department, 

Office  of  Commissioner  of  Internal  Revenue, 

Washington,  D.  C.,  Sept.  1,  1879. 

Hereafter,  every  claim  for  the  abatement  or-  refunding  of  taxes 
should  contain,  at  its  close,  a  statement,  under  oath,  in  the  following 
form: 

"The  above  statements,  together  with  those  heretofore  made  in 
writing  and  filed  as  evidence  by  the  claimant,  embrace  all  the  facts 
known  to  the  claimant  on  which  this  claim  is  founded." 

Collectors  and  Deputy  Collectors,  assisting  in  the  preparation  of 
new  claims  or  in  the  completion  of  claims  returned  for  additional  evi- 
dence, will  take  care  that  the  above  statement  is  supplied  or  its  omis- 
sion explained. 

H.  C.  ROGERS, 
Acting  Commissioner. 
Approved : 

JOHN  SHERMAN, 

Secretary  of  the  Treasury. 


208  THE    INCOME   TAX 

The  provisions  of  the  above  circular  are  not  always  applicable. 
The  circular  has  been  quoted  merely  that  taxpayers  may  not  be  mys  - 
tified  as  to  the  meaning  of  the  footnote  on  Form  47. 

375.— CLAIMS  FOR  ALL  TAXES. 

Claims  for  refund  and  abatement  can  be  filed  with  respect  to  all 
Federal  internal  taxes  assessed,  and  claims  for  refund  can  be  filed  for 
taxes  the  payment  of  which  is  denoted  by  the  use  of  stamps.  In  the 
latter  case,  however,  the  stamps  representing  the  payment  desired  re- 
funded should  be  attached  to  the  claim  if  they  have  not  been  used,  or, 
if  they  have  been  affixed  to  taxable  articles  or  containers  of  taxable 
articles,  they  should  be  removed  in  the  presence  of  an  internal  rev- 
enue officer  and  attached  to  the  claim. 


THE    INCOME   TAX  209 


CHAPTER  XXIV 


THE  INCOME  TAX 


EXTRA   INCOME  TAX   IMPOSED   BY 
ACT  OF  OCTOBER  3,   1917 


One  of  the  heaviest  and  most  far-reaching  of  the  taxes  imposed 
by  the  War  Revenue  Act  of  October  3,  1917  is  the  War  Income  Tax — 
a  tax  which  does  not  take  the  place  of  the  Regular  Income  Tax  still 
in  effect  under  the  Act  of  September  8,  1916,  but  is  to  be  assessed  and 
collected  in  addition  to  that  tax. 

This  War  Income  Tax  affects  both  individuals  and  corporations. 

It  is  applicable  to  income  for  the  entire  year  1917. 

With  only  a  few  exceptions  the  method  of  computation  is  the 
same  as  that  for  the  Regular  Income  Tax  under  the  Act  of  September 
8,  1916.  The  exceptions  will  be  emphasized;  but,  in  general,  the  in- 
dividual or  corporation  should  turn  to  and  can  rely  on  the  instructions 
given  in  detail  with  reference  to  the  Regular  Income  Tax. 

The  Treasury  Department  will  call  for  only  one  return  to  cover 
both  the  Regular  and  the  War  Income  Taxes,  in  the  case  of  either  an 
individual  or  a  corporation. 

376.— THOSE  WHO  HAVE  NOT 
FILED  UNDER  OLD   LAW. 

Those  individuals  whose  incomes  were  not  sufficient  to  make 
them  liable  to  file  returns  under  the  provisions  of  the  old  law,  Act  of 
September  8,  1916,  should  first  determine  the  question  of  their 
liability  to  file  under  the  provisions  of  the  new  law,  Act  of  October  3. 
1917,  as  explained  in  this  chapter.  They  should  then  turn  to  instruc- 
tions given  in  other  chapters  for  information  as  to  the  preparation 


210  THE    INCOME   TAX 

and  filing  of  a  return  and  for  definitions  of  income  required  to  be  in- 
cluded and  deductions  allowed.  The  requirements  of  the  Government 
with  respect  to  returnable  income  and  allowable  deductions  under  the 
old  law  apply  to  income  and  deductions  under  the  new  law. 

Reference  has  just  been  made  to  "liability  to  file  return."  This  is 
not  the  same  as  "liability  to  tax,"  and  the  distinction  should  be  noted. 
For  instance,  a  single  person  with  a  net  income  of  exactly  $1,000  is 
liable  to  file  return  but  is  not  liable  to  tax  since  after  he  has  filed  re- 
turn and  therein  claimed  the  benefit  of  the  specific  exemption  of 
$1,000  allowed  him,  there  remains  no  excess  on  which  to  assess  tax. 

377.— THOSE  WHO  HAVE 

FILED  UNDER  OLD  LAW. 

Those  individuals  who  have  filed  returns  under  the  old  law  will 
have  to  ascertain  their  liability  to  tax  under  both  old  and  new  laws. 
They  will  be  subject  to  all  the  normal  tax  heretofore  imposed  by  the 
old  law  and,  in  addition,  will  be  subject  to  the  new  normal  tax  on  the 
amount  of  net  income  in  excess  of  the  lowered  exemption.  In  case  of 
sufficient  income  they  will  also  be  subject  to  the  new  additional,  or 
super-tax,  imposed  by  the  new  law  of  October  3,  1917  on  net  income 
in  excess  of  $5,000  and,  if  their  net  income  is  in  excess  of  $20,000,  will 
be  subject  to  both  the  old  and  the  new  additional  taxes,  each  com- 
puted according  to  its  own  scale  of  graduation. 

However,  the  above  point  is  explained  and  illustrated  in  de- 
tail in  instructions  relative  to  "Combined  Computation  of  Income  Tax 
under  Both  Laws." 

378.— INDIVIDUAL  EXEMPTION  LOWERED. 

The  most  far-reaching  extension  of  the  taxation  of  income,  car- 
ried by  the  War  Income  Tax  part  of  the  War  Revenue  Act,  is  to  be 
found  in  the  lowering  of  the  specific  exemption  to — 

$1,000  in  the  case  of  a  single  person,  who  is  not  the  head  of 

a  family,  and 

$2,000  in  the   case   of   a   married  person  living  with  wife  or 
husband,  or  in  the  case  of  a  single  person 
who  is  the  head  of  a  family,  with  an  allow- 
ance of  $200  for  each  dependent  child. 

This  means,  of  course,  that  many  individuals  who  are  not  liable 
under  the  Act  of  September  8,  1916  must  pay  tax  under  the  Act  of 
October  3,  1917. 

It  also  means  that  those  who  are  liable  under  the  Act  of  Septem- 
ber 8,  1916  are  also  liable  under  the  Act  of  October  3,  1917  with  their 


TIIK    INCOME   TAX  211 

liability  increased  by  the  lowering  of  the  specific  exemption  and  by 
the  application  of  the  tax  imposed  by  the  new  law  to  all  the  income 
also  taxable  under  the  old  law. 

379.— AMOUNT  MAKING  RETURN  NECESSARY. 

Under  the  provisions  of  the  War  Income  Tax  law  every  single 
person  with  a  net  income  of  $1,000  or  over,  and  every  married  person 
with  a  net  income  of  $2,000  or  over  is  required  to  file  a  return  of  in- 
come. 

The  amount  of  $1,000  in  the  case  of  a  single  person  and  $2,000  in 
the  case  of  a  married  person  fixes  liability  to  file  return,  just  as  the 
amount  of  $3,000  fixed  such  liability  to  file  return  on  the  part  of  both 
single  and  married  persons  under  the  Act  of  September  8,  1916. 

The  question  of  liability  to  file  a  return  (to  make  a  report  to  the 
Government)  must  therefore  be  determined  solely  by  the  provisions 
of  the  new  law,  the  War  Income  Tax  part  of  the  Act  of  October  3, 
1917.  This  follows  from  the  fact  that  every  individual  citizen  or  resi- 
dent of  the  United  States  who  is  liable  to  file  a  return,  according  to 
the  requirements  of  the  old  law,  is  also  liable  to  file  under  the  pro- 
visions of  the  new  law ;  and  many  who  were  not  liable  to  file  returns 
under  the  old  law  are  liable  to  file  under  the  new  law. 

Liability  to  file  a  return,  then,  must  be  determined  by  the 
amounts  specified  in  the  new  law — $1,000  for  a  single  person  and 
$2,000  for  a  married  person,  such  amounts  representing  net  income, 
not  gross  income. 

380.— NEW  NORMAL  TAX 
ON  INDIVIDUALS. 

The  new  normal  tax,  imposed  by  the  War  Income  Tax  part  of  the 
Act  of  October  3,  1917,  is  at  the  rate  of  2  per  cent  upon  taxable  net 
income  of  individuals,  ascertained  exactly  as  in  the  computation  for 
the  old  normal  tax  under  the  Act  of  September  8,  1916,  except  that 
the  lowered  exemption  of  the  new  law  takes  the  place  of  the  exemp- 
tion of  the  old  law.  In  other  words,  the  new  normal  tax  is  assessed 
upon  all  taxable  net  income  in  excess  of  $1,000  or  $2,000  (plus  $200  for 
each  dependent  child),  while  the  old  normal  tax  is  assessed  only  upon 
taxable  net  income  in  excess  of  $3,000  or  $4,000,  the  exemption  vary- 
ing according  to  the  single  or  married  or  "head-of-a-family"  status  of 
the  individual  making  the  return. 

381.— NEW  ADDITIONAL  TAX 
ON  INDIVIDUALS. 

The  new  additional  tax,  imposed  by  the  War  Income  Tax  part  of 


212  THE    INCOME   TAX 

the  Act  of  October  3,  1917,  is  assessed  upon  all  net  income  in  excess 
of  $5,000  according  to  the  following  graduated  scale : 

1  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $5,000  and  does  not  exceed  $7,500. 

2  per  cent  upon  the  amount  by  which  total   net    income 
exceeds  $7,500  and  does  not  exceed  $10,000. 

3  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $10,000  and  does  not  exceed  $12,500. 

4  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $12,500  and  does  not  exceed  $15,000. 

5  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $15,000  and  does  not  exceed  $20,000. 

7  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $20,000  and  does  not  exceed  $40,000. 

10  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $40,000  and  does  not  exceed  $60,000. 

14  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $60,000  and  does  not  exceed  $80,000. 

18  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $80,000  and  does  not  exceed  $100,000. 

22  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $100,000  and  does  not  exceed  $150,000. 

25  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $150,000  and  does  not  exceed  $200,000. 

30  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $200,000  and  does  not  exceed  $250,000. 

34  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $250,000  and  does  not  exceed  $300,000. 

37  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $300,000  and  does  not  exceed  $500,000. 

40  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $500,000  and  does  not  exceed  $750,000. 

45  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $750,000  and  does  not  exceed  $1,000,000. 

50  per  cent  upon  the  amount  by  which  total  net  income 
exceeds  $1,000,000. 

The  application  of  this  new  additional  tax  scale  (either  alone  as 
in  the  case  of  a  net  income  exceeding  $5,000  but  not  exceeding  $20,000, 
or  in  combination  with  the  old  additional  tax  as  in  the  case  of  a  net  in- 
come exceeding  $20,000)  is  explained  and  illustrated  in  instructions 
relative  to  "Combined  Computation  of  Income  Tax  under  Both 
Laws." 


THE    INCOME   TAX  2B 

382.— NON-RESIDENT  ALIENS 
AND  NEW  TAX  RATES. 

The  application  of  the  new  tax  (Act  of  October  3,  1917)  is 
restricted  to  the  income  of  citizens  and  residents  of  the  United 
States.  All  citizens  of  the  United  States,  whether  residing  at  home 
or  abroad,  and  all  aliens  residing  in  the  United  States  are  subject  to 
it,  but  aliens  who  are  not  residents  of  the  United  States  do  not  have 
to  pay  the  new  tax  upon  their  income  from  sources  within  the  United 
States.  They  do,  however,  remain  liable  to  the  old  tax  imposed  by  the 
Act  of  September  8,  1916. 

383.— NEW  TAX  ON  CORPORATIONS. 

The  new  tax,  imposed  by  the  War  Income  Tax  part  of  the  Act  of 
October  3,  1917,  upon  the  income  of  corporations  is  at  the  rate  of  4 
per  cent  upon  total  net  income  ascertained  exactly  as  under  the  Act 
of  September  8,  1916,  with  the  notable  exception  that  in  the  computa- 
tion of  the  War  Income  Tax  a  corporation  is  allowed  a  credit  of  the 
amount  received  as  dividends  upon  the  stock  of  another  taxable  cor- 
poration. This  credit  is  not  allowed  in  the  computation  under  the  Act 
of  September  8,  1916. 

384.— IN  CASE  OF  FISCAL-YEAR  RETURN. 

If  a  corporation  has  fixed  its  own  fiscal  year  and  makes  return 
according  to  that  period,  the  4  per  cent  rate  of  the  War  Income  Tax 
is  applicable  to  net  income  shown  in  a  return  for  a  fiscal  year  ending 
in  the  calendar  year  1917  only  upon  that  proportion  of  such  income 
which  the  period  between  January  1,  1917  and  the  end  of  its  fiscal 
year  bears  to  the  whole  of  such  fiscal  year.  For  example :  A  corpor- 
ation has  established  the  right  to  file  return  for  a  fiscal  year  ending 
with  the  last  day  of  August.  In  such  a  case  only  eight-twelfths  of 
the  net  income  shown  by  its  return  (and  with  the  credit  for  dividends 
from  other  corporations  considered)  would  be  subject  to  the  new  4 
per  cent  rate.  Thereafter,  however,  there  would  be  no  such  appor- 
tionment as  the  return  for  each  succeeding  fiscal  year  would  be  for  a 
period  wholly  within  the  time  beginning  January  1,  1917,  the  effective 
date  of  the  newr  rate. 

385.— DEDUCTION  OF  TAX  AT  SOURCE. 

The  provisions  of  the  Act  of  September  8,  1916,  as  amended,  with 
respect  to  deduction  at  the  source  of  the  normal  tax  when  the  income 
is  in  the  form  of  interest  paid  on  bonds  containing  the  so-called  "tax- 
free"  guaranty,  are  made  applicable  to  the  normal  tax  upon  income 


214  THE    INCOME   TAX 

in  the  same  form  due  under  the  new  law.  This  clause  is  so  restricted 
in  its  application,  however,  that  it  is  not  effective  at  all  until  January 
1,  1918,  and  even  from  that  date  no  deduction  at  the  source  is  allowed, 
under  the  operation  of  both  income  tax  laws,  of  more  than  one  2  per 
cent  normal  tax.  If,  after  that  date,  the  recipient  of  the  income  is 
subject  to  both  2  per  cent  normal  taxes  (under  the  old  and  the  new 
law),  only  one  of  such  taxes  can  be  deducted  at  the  source  and  the 
Government  will  look  to  the  individual  recipient  of  the  income  for  the 
collection  of  any  remaining  normal  tax  due. 

386.— NOT  APPLICABLE  TO 

PORTO  RICO  AND  PHILIPPINES. 

The  provisions  of  the  War  Income  Tax  law  are  not  applicable  to 
Porto  Rico  and  the  Philippine  Islands.  The  provisions  of  the  Act  of 
September  8,  1916  (the  old  or  regular  income  tax  law)  have  been 
applicable ;  but  the  War  Income  Tax  law  not  only  exempts  Porto  Rico 
and  the  Philippine  Islands  from  its  own  provisions  but  also  empowers 
the  Insular  legislatures  to  amend  or  repeal  the  income  tax  provisions 
of  the  old  law  as  such  provisions  affect  the.  island  possessions. 


THE    INCOME   TAX  215 


CHAPTER  XXV. 


ILLUSTRATIVE  CASES 


INCOME  TAX 


In  addition  to  the  illustrations  given  throughout  the  book  several 
illustrative  cases  of  the  application  of  the  Income  Tax,  under  both  the 
old  and  the  new  laws,  are  worked  out  in  the  examples  that  follow. 

It  is  suggested  that  these  be  followed  carefully  and  that  every 
reference  to  a  paragraph  be  noted.  The  references  to  paragraphs  will 
lead  to  instructions  based  upon  decisions  of  the  Treasury  Department 
and  actual  administration  of  the  Income  Tax  law. 

While  only  a  few  illustrative  cases  have  been  given,  many  im- 
portant points  are  covered  by  them. 

Do  not  be  misled  by  the  heading  over  each  case  (for  instance, 
"A  BANKER-INVESTOR,"  "A  PHYSICIAN,"  "A  MERCHANT," 
etc.)  into  a  conclusion  that  the  illustration  applies  only  to  the  income 
of  a  person  engaged  in  the  same  business,  or  trade,  or  practicing  the 
same  profession.  There  are  points  touched  upon,  and  principles  ap- 
plied, in  each  case  that  affect  every  person. 


A  BANKER-INVESTOR 


John  Burnside  is  president  of  the  Second  National  Bank  of  San  Francisco, 
Gal.  He  is  a  widower  but  supports  his  aged  mother  and  two  daughters,  of  11 
and  21  years  of  age,  respectively.  He  maintains  a  country  place  at  Burlingame, 
but  the  greater  part  of  the  year  resides  in  city  apartments  which  he  keeps 
under  lease  at  an  annual  rental  of  $6,000. 

Early  in  the  year  1917  Burnside  traded  in  his  old  automobile  and  obtained 
a  new  one,  paying  in  cash  in  the  transaction  the  amount  of  $3,000.  He  had  a 
chauffeur  employed  during  the  entire  year,  at  a  wage  of  $85  a  month,  to  keep  the 
car  always  at  the  personal  disposal  of  himself  and  family. 


.216  THE    INCOME   TAX 

He  also  had  to  keep  two  caretakers  on  his  country  place  at  a  cost  of  $80  a 
month  in  wages  and  allowed  them  to  purchase  their  food  supplies  at  Burlin- 
game  stores,  the  bills  for  such  supplies  having  been  presented  to  him  each 
month  for  payment,  the  total  payments  for  the  year  being  $650.  He  also  had 
to  make  repairs  on  his  country  home  during  the  year  at  a  cost  of  $1,200. 

Burnside's  town  household  servants  cost  him  $900  during  the  year  1917. 
At  the  end  of  the  year  he  also  found  that  clothing  for  himself  and  family  had 
cost  $5,000  during  the  year.  Having  desired  to  aid  in  war  work,  he  gave  $1,500 
to  the  Red  Cross  in  March.  He  also  had  to  make  the  annual  payment  of  $240 
on  a  college  scholarship  which  he  endowed  years  ago.  Dancing  and  music  les- 
sons for  his  daughters  cost  $600. 

Burnside  also  found  in  going  over  his  accounts  that  dues  and  other  ex- 
penses in  his  clubs  amounted  to  $720. 

Late  in  1916  he  borrowed,  on  securities  as  collateral,  $20,000  and  with  the 
money  invested  in  bonds  of  Valley  Irrigation  District  No.  2,  thereby  helping  to 
promote  a  project  for  the  watering  of  a  territory  in  which  he  owns  land.  He 
pays  the  bank  6  per  cent  for  the  money  and  in  1917  made  one  such  annual  pay- 
ment. He  has  also  received  6  per  cent  interest  on  the  bonds. 

He  has  other  indebtedness  to  banks  on  which  during  1917  he  paid  interest 
amounting  to  $2,800.  This  indebtedness  was  incurred  for  investment  in  country 
lands. 

He  paid  local  taxes  in  1917  to  the  amount  of  $2,342,  and  a  Federal  income 
tax  in  June,  1917,  of  $968,  assessed  upon  his  net  income  for  the  year  1916. 

Aside  from  his  duties  at  the  bank,  Burnside  found  time  to  make  invest- 
ments in  the  stock  and  bond  market.  On  some  magnesite  stock  which  he 
bought  early  in  the  year  and  sold  in  December  he  made  a  profit  of  $15,000;  some 
Mexican  silver  stock  he  sold  during  the  year  for  $22,000  less  than  he  had  paid 
tor  it  two  years  before;  some  electric  railway  bonds,  which  he  still  held  at  the 
end  of  1917,  he  found  to  be  worth,  according  to  the  market,  only  $16,000,  where- 
as he  had  paid  $28,000  for  them  three  years  before. 

His  annual  salary  at  the  bank  is  $24,000.  His  dividends  from  corporation 
stocks  during  1917  amounted  to  $41,000.  He  also,  in  November,  1917,  sold  some 
of  his  country  lands  at  a  profit  of  $110,000.  Also  from  the  estate  of  a  deceased 
friend  there  came  to  him  by  inheritance  during  the  year  $90,000  in  cash. 

What  income  tax  does  Burnside  owe  for  the  year  1917,  and  how 
would  he  make  the  computation? 


ANSWER. 


[Comment:  In  order  not  to  confuse  the  Excess  Profits  Tax  computation 
with  this  sample  Income  Tax  computation,  it  is  assumed,  merely  for  the  pur- 
pose of  the  example,  that  Burnside's  Excess  Profits  Tax,  assessed  for  the  year 
1917,  is  $5,000.  In  an  actual  case,  the  actual  amount  of  such  tax  would  appear 
as  the  $5,000  does  below.] 


Burnside's  returnable  gross  income  consists  of: 

Salary  from  bank ....$  24,000 

Profit  on  sale  of  lands 110,000 

Profit  on  magnesite  stock 15,000 

Dividends    .  41,000 


Total  gross  income .$190,000 


His  allowable  deductions  are: 

Interest  paid  on  money  borrowed  for  investment  in  lands $  2,800 

Local  taxes  paid 2,342 

Of  $22,000  loss  on  Mexican  silver  stock,  only  (See  Note  1,  below) 15,000 


THE    INCOME    TAX  217 

Gift  to  Red  Cross.     (See  Note  2,  below) 1,500 

Payment  on  scholarship.     (See  Note  2,  below) 240 


Total  deductions  $  21,882 


His  net  income  is: 
$190,000  minus  $21,882,  or $168,118 


His  net  income  on  which  income  tax  can  be  assessed  is: 
$168,118  minus  $5,000  excess  profits  tax  assessed  for  same  year,    (Note 
3,  below)   ....$163,118 


His  net  income  subject  to  normal  tax  is: 
$163,118  minus  $41,000  received  as  dividends  (Note  4,  below)  $122,118 


His  exemption  is: 
$2,200  under  new  law  and  $4,200  under  old  law  (Note  5,  below) 


His  normal  tax  is:     (Note  6,  below) 

2  per  cent  of  $2,000 $     40. 

4  per  cent  of  $117,918....  ..  4716.72 


Total  normal  tax $  4,756.72 


His  net  income  subject  to  additional  tax  is: 
$163,118,  with  no  deduction  of  dividends  (Note  4,  below) 


His  additional  tax  is: 

On  $2,500  between  $5,000  and  $7,500  at  1  per  cent 25. 

On  $2,500  between  $7,500  and  $10,000  at  2  per  cent 50. 

On  $2,500  between  $10,000  and  $12,500  at  3  per  cent 75. 

On  $2,500  between  $12,500  and  $15,000  at  4  per  cent 100. 

On  $5,000  between  $15,000  and  $20,000  at  5  per  cent 250. 

On  $20,000  between  $20,000  and  $40,000  at  8  per  cent 1,600. 

On  $20,000  between  $40,000  and  $60,000  at  12  per  cent 2,400. 

On  $20,000  between  $60,000  and  $80,000  at  17  per  cent 3,400. 

On  $20,000  between  $80,000  and  $100,000  at  22  per  cent 4,400. 

On  $50,000  between  $100,000  and  $150,000  at  27  per  cent 13,500. 

On  $13,118  over  $150,000  at  31  per  cent 4,066.58 


Total  additional  tax....  ....$29.866.58 


His  total  tax  is : 

Normal    tax $  4,756.72 

Additional   tax...  ..  29,866.58 


Total  income  tax $34,623.30 


Notes 


1. — Allowable  under  Department  interpretation  of  the  law  to  an  amount  not 
in  excess  of  profit  same  year  from  similar  transaction. 

[SEE    PAR.    90-92-93-94] 

2. — Sum  of  these  two  gifts  does  not  exceed  15  per  cent  of  taxable  net  in- 
come as  it  would  be  without  the  allowance  of  deduction  of  these  gifts.  There- 


218  THE    INCOME   TAX 

fore,  the  gifts,  considering  their  character,  are  deductible  in  full. 

[SEE    PAR.    101] 

3. — Amount  of  excess  profits  tax  assessed  for  the  same  year  allowed  as 
credit  against  net  income  for  assessment  of  income  tax. 

[SEE    PAR.    103.] 

4. — Individual  allowed  credit  for  dividends  from  taxable  corporation  in 
assessment  of  normal  tax  but  not  for  additional  tax. 

[SEE    PAR.    104.] 

5. — He  is  the  head  of  a  family;  also  he  has  one  dependent  child  under  18 
years  of  age. 

[SEE    PAR.    4    (SUB.    PAR.    4)    ALSO    PAR.    105-106.] 

6. — New  law  rate  applies  on  amount  over  new  law  exemption  and  not  in  ex- 
cess of  old  law  exemption.  Combined  rates  apply  to  all  over  old  law  exemption. 

[SEE    PAR.    3    AND    PAR.    4    (SUB.    PAR.    5.)] 

7. — The  following  expenditures  by  Burnside  are  personal,  living  or  family, 
and,  therefore,  not  deductible:  $6,000  rent  for  city  apartments;  $3,000  paid  for 
automobile  for  personal  and  family  use,  and  $85  a  month  for  chauffeur;  $1,200 
ppent  in  repairing  country  home;  $80  a  month  paid  caretakers;  $650  paid  for 
caretakers'  supplies;  $900  paid  for  household  servants;  $5,000  for  clothing  for 
family  and  himself;  $600  for  dancing  and  art  lessons  of  daughters;  $720  for  club 
expenses. 

[SEE    PAR.    69.] 

8. — Interest  on  the  $20,000  borrowed  to  buy  Irrigation  District  bonds  is  not 
deductible. 

[SEE    PAR.    80-65-66.] 

9. — Interest  received  on  Irrigation  District  bonds  is  exempt  from  tax,  there- 
fore, 6  per  cent  received  on  $20,000  in  bonds  need  not  be  included  in  return. 

[SEE    PAR.    62-65-66.] 

10. — He  has  not  disposed  of  his  electric  railway  bonds;  therefore  cannot  de- 
iuct  the  amount  by  which  they  have  depreciated. 

[SEE    PAR.    90-311.] 

11. — The  $90,000  received  by  inheritance  is  exempt  from  income  tax. 

[SEE    PAR.   64.] 


A  FARMER 


Henry  Smith  owns  and  farms  640  acres  of  land.  He  lives  with  his  family 
on  the  farm,  his  family  consisting  of  a  wife,  a  son  of  19  years  and  two 
daughters,  one  9  and  the  other  16  years  of  age.  The  elder  daughter  he  has  had 
in  boarding  school  at  a  cost  during  the  year  of  $600. 

Two  years  ago  Smith  set  80  acres  of  his  land  to  peach  trees.  Another  lot 
of  80  acres  is  in  vineyard  which  has  been  in  full  bearing  for  two  years.  A  third 
lot,  160  acres,  is  in  alfalfa.  On  a  fourth  lot,  160  acres,  he  produced  a  crop  of 
beans  but  was  still  holding  the  beans  at  the  end  of  the  year  for  a  better  price. 
He  had,  however,  early  in  1917  sold  a  crop  of  beans  held  over  from  the  harvest 
of  1916.  The  remaining  160  acres  of  his  land  Smith  planted  during  the  year 
1917  to  two  crops — barley  which  he  harvested  for  hay  in  the  early  summer  and 
corn  which  he  harvested  in  the  late  fall.  He  fed  a  part  of  the  hay  to  his  stock 
and  sold  part  of  it.  He  used  all  the  corn  to  fatten  his  hogs. 

Smith's  farm  was  under  a  mortgage  for  $20,000  to  a  bank  at  the  beginning 
of  the  year  1917  and  on  the  loan  Smith  paid  a  year's  interest  at  6  per  cent  dur- 
ing the  year.  However,  he  was  able  also  to  pay  $5,000  on  the  principal  of  the 
loan  during  the  year,  so  that  the  encumbrance  on  his  place  at  the  end  of  the 
year  was  only  $15,000. 


THE    INCOME    TAX  219 

His  local  taxes  during  1917  amounted  to  $822  and  on  June  10,  1917  he  paid  a 
Federal  income  tax  of  $190  which  had  been  assessed  upon  his  income  for  the 
year  1916. 

Early  in  1917  Smith  bought  some  livestock  from  a  neighbor  farmer.  In  the 
lot  were  four  mules,  a  bull  and  20  head  of  steers  and  calves.  He  contemplated 
using  the  mules  for  farm  work,  keeping  the  bull  for  breeding  purposes,  and 
fattening  and  selling  the  steers  and  calves.  For  the  stock  Smith  paid  his  neigh- 
bor as  follows :  $500  for  the  bull,  $400  for  the  mules  and  $500  for  the  steers  and 
calves.  Early  in  December  he  sold  the  steers  and  calves  for  beef  and  still  had 
and  was  working  the  mules.  A  month  before  that,  however,  the  bull  had  be- 
come entangled  in  a  barbed  wire  fence  and  become  so  badly  cut  that  it  died  a 
few  days  later. 

Toward  the  end  of  the  year  Smith  found  that  he  had  sold  too  much  of  his 
barley  hay  and  had  to  buy  $400  worth  for  his  stock.  During  1917  he  also  bought 
the  following  farm  equipment:  a  motor  tractor  for  which  he  paid  $2,000,  a 
feed-cutting  machine  for  $150,  and  shovels,  axes,  pruning  shears  and  plows  cost- 
ing $275. 

Smith  also  had  to  build  an  addition  to  his  barn  at  a  cost  of  $550,  and  to  re- 
pair the  roof  of  the  old  part  of  the  barn  at  an  expense  of  $90.  He  also  had  to 
pay  an  irrigation  district  assessment  amounting  to  $320. 

He  kept  10  men  throughout  the  year,  paying  them  $45  a  month  and  found. 
The  men  ate  in  quarters  specially  provided  for  them  and  a  cook  was  employed 
for  them  throughout  the  year,  her  wages  being  $40  a  month.  At  various  times 
during  the  harvest  extra  help  to  take  care  of  crops  had  to  be  employed  at  a 
total  cost  for  the  year  for  such  extra  help  of  $1,700.  Smith  also  paid  out  for 
barley  and  corn  seed  during  the  year  $800,  and  for  a  fertilizer  to  use  in  his  vine- 
yard, $500. 

Smith  paid  $1,000  for  clothing  for  himself  and  family  during  the  year.  The 
family's  food  bills  amounted  to  $1,600,  and  those  for  his  employees  to  $1,850. 
He  also  had  to  spend  $200  repairing  the  basement  of  the  family  residence  on 
the  farm. 

Smith  sold  during  the  year  120  tons  of  raisins  at  $110  a  ton;  650  head  of 
hogs  of  a  gross  weight  of  146,250  pounds  at  16  cents  a  pound  live  weight;  cattle, 
including  those  bought  from  his  neighbor,  for  $8,200;  and  barley  hay  to  the 
amount  of  $2,750.  For  his  1916  bean  crop  he  received  $15,620.  A  friend,  who 
had  borrowed  $2,000  from  him  two  years  before,  repaid  him,  both  the  principal 
and  8  per  cent  interest  for  two  years. 

How  would  Smith  make  up  his  income  tax  return  for  1917? 


ANSWER. 


Smith's  items  of  returnable  gross  income  would  be : 
Proceeds  from  sale  of  120  tons  of  raisins  at  $110  a  ton; 
Proceeds  from  sale  of  hogs  at  16  cents  live  weight; 
The  $8,200  from  sale  of  cattle; 
The  $2,750  from  sale  of  hay; 

The  $15,620  from  sale  of  1916  bean  crop  in  1917  (Note  1,  below) 
The  two  years  interest  at  8%  received  by  him  when  his  friend  paid  the  note  of 

$2,000.     (Note  6,  below) 


His  allowable  deductions  would  be: 

As  Business  Expenses: 

The  $500  paid  his  neighbor  for  steers  and  calves  (Note  2,  below) 
The  $400  paid  for  hay  to  feed  stock.     (Note  3,  below) 

The  $275  paid  for  shovels,  axes,  pruning  shears  and  plows.     (Note  4,  below) 
The  $90  spent  repairing  roof  of  old  barn.     (Note  5,  below) 
The  wages  paid  his  10  regular  men. 
The  $1,700  paid  for  extra  help. 


220  THE    INCOME   TAX 

The  $1,850  paid  for  food  for  men. 
The  wages  of  employees'  cook. 
The  $800  paid  for  barley  and  corn  seed. 
The  $500  paid  for  fertilizer. 

Other  Deductions: 
The  interest  paid  at  6  per  cent  on  the  $20,000  loan  secured  by  mortgage  on  his 

farm. 

Local  taxes  of  $822. 

Loss  to  amount  of  $500,  cost  of  bull  killed.     (Note  7,  below) 
Depreciation  on  full-bearing  vineyard.     (Note  8,  below) 

Depreciation  on  farm  buildings,  except  house  occupied  by  Smith  and  family. 
Depreciation  on  four  mules  bought  from  neighbor.     (Note  9,  below) 
Depreciation  on  tractor  and  feed-cutting  machine.     (Note  10,  below) 


Smith's  net  income  would  be  ascertained  by  subtracting  the  total  of  his  de- 
ductions from  the  total  of  his  gross  income.  He  would  then  be  allowed  a  credit 
against  such  net  income  of  the  amount  of  Excess  Profits  tax,  if  any,  assessed  for 
the  year  1917.  This  would  be  done  before  assessment  of  income  tax. 

[SEE    PAR.    1— Par.    4    (SUB.    PAR.    1    AND    2)    AND    PAR.    103.] 


Smith's  exemption  is  $2,400  under  the  new  law  and  $4,400  under  the  old  law. 
(Note  11,  below.) 


With  the  exception  that  he  received  no  dividends,  his  tax  would  then  be 
figured  as  in  example  of  "A  BANKER-INVESTOR." 
[SEE    PAR.   4,    (complete.)] 


The  following  expenditures  by  Smith  during  1917  were  personal,  living  or 
family  expenses  and  not  deductible  in  his  return:  $600  for  daughter  in  boarding 
school;  $1,000  for  clothing  for  himself  and  family;  $1,600  for  food  supplies  for 
family;  $200  repairing  basement  of  house  occupied  by  family  on  farm. 

[SEE    PAR.    69.] 


Smith's  payment  of  $5,000  on  the  principal  of  the  loan  secured  by  a  mort- 
gage on  his  farm  is  not  deductible.  The  amount  of  interest  paid  on  the  loan  is 
deductible  but  not  any  payment  on  principal.  The  payment  of  the  $5,000  was 
entirely  a  capital  transaction  and  not  an  expense.  It  was  merely  a  return  by 
Smith  of  money  previously  obtained  by  him  and  not  accounted  for  as  income 
when  so  obtained. 

[SEE    PAR.   80.] 


The  $500  Smith  paid  his  neighbor  for  the  bull  and  the  $400  for  mules  can- 
not be  deducted.  Both  amounts  represent  capital  investment,  since  the  bull 
was  for  breeding  purposes  and  the  mules  were  for  work  on  the  farm.  These 
animals,  therefore,  were  a  part  of  the  operating  equipment  of  Smith's  business. 
The  $500  paid  for  the  steers  and  calves  is  allowable  as  an  expense.  (Note  2, 
below) 


The  $2,000  paid  for  a  tractor  and  the  $150  for  a  feed-cutting  machine  repre- 
sent investment  in  equipment  and  are  not  deductible.     (Note  4.  below) 


The  $550  which  Smith  put  into  an  addition  to  his  barn  cannot  be  deducted. 
It  represents  a  further  investment  in  farm  equipment.     (Note  5,  below) 


The  $2,000  received  by  Smith  in  payment  of  the  principal  of  a  note  should 
not  be  included  by  him  in  his  return.  It  is  not  income;  it  represents  merely  a 
return  of  capital  to  his  possession.  The  two  years'  interest,  however,  repre- 
sents income — the  earnings  of  the  capital  represented  by  the  principal  of  the 
note.  (Note  6,  below) 


THE    INCOME    TAX  221 

Smith's  peach  trees  are  only  two  years  old  and  therefore  have  not  reached 
a  productive  stage.  No  depreciation  can  be  charged  on  them.  However,  the 
cost  of  bringing  them  to  a  stage  of  production  is  being  lumped  in  and  deducted 
with  other  farm  expenses;  therefore,  such  carrying  charges  cannot  be  added  to 
original  price  paid  for  trees  to  get  total  cost  basis  for  depreciation  when  trees 
do  become  productive.  (Note  8,  below) 


The  beans  produced  in  1917  need  not  be  accounted  for  until  sold — converted 
Jnto  cash  or  the  equivalent  of  cash.     (Note  1,  below) 


No  account  should  be  taken  of  the  value  of  hay  and  corn  produced  on  the 
farm  and  fed  to  animals  on  the  farm.  Cost  of  production  is  taken  care  of  in 
general  expenses  of  operating  farm. 


Smith's  Federal  income  tax  of  $190,  paid  in  1917  upon  income  for  1916  can 
not  be  deducted;  neither  can  his  irrigation  district  tax  of  $320. 
[SEE    PAR.   81-82.] 


Notes 


1. — Farm  products  to  be  accounted  for,  returned  as  income  of  year  when 
converted  into  cash.  Cost  of  producing  them  to  be  deducted  in  year  of  ex- 
penditure. 

[SEE    PAR.    45-46.] 

2. — Cost  of  animals  purchased  by  farmer  for  resale  during  year  deductible 
as  business  expense. 

[SEE    PAR.    49-78.] 

3. — Expense  of  feeding  stock  is  expense  to  farmer  same  as  cost  of  fuel  for 
mrnace  is  to  manufacturer. 

[SEE    PAR.   78.] 

4. — Expenditures  for  ordinary  farm  tools  deductible  as  expense;  but  ex 
Denditures  for  farm  machinery  represent  investment. 

[SEE    PAR.   51.] 

5. — Cost  of  ordinary  repairs  to  business  property  is  allowable  as  business 
expense,  but  not  the  cost  of  permanent  improvements. 

[SEE    PAR.   72.] 

6. — Interest  must  be  returned  as  income  for  year  in  which  received,  even 
though  the  amount  may  have  accrued  for  more  than  one  year.  A  payment  re- 
ceived on  principal  is  not  income. 

[SEE    PAR.    32.] 

7. — Smith  invested  $500  of  his  capital  in  the  bull  he  bought  from  his  neigh- 
bor. The  bull  was  part  of  his  business  property.  But  the  investment  was  wiped 
out  by  the  accidental  death  of  the  bull.  Therefore,  Smith  sustained  a  business 
loss  by  casualty  during  the  year,  measured  by  the  cost  of  the  bull,  the  animal 
not  having  been  insured. 

[SEE    PAR.    50-89-91.] 

8. — Depreciation  allowed  on  orchard  or  vineyard  only  when  it  has  reached 
stage  of  production.  Assuming  that  while  he  was  bringing  vineyard  to  stage  of 
production  Smith  did  not  keep  separate  account  of  expense  applied  to  it  as  dis- 
tinguished from  the  rest  of  his  farm,  he  cannot  add  such  carrying  expense  to 
original  cost  of  vines  when  they  were  planted  to  get  cost  basis  of  depreciation. 
His  basis  is  original  cost  of  vines.  Annual  rate  of  depreciation  should  be  ascer- 
tained by  spreading  original  cost  of  vines  ratably  over  their  probable  life. 

[SEE    PAR.    99-264-265-273.] 

9. — Animals  bought  for  working  purposes  are  business  property  that  de- 
preciate from  their  use  in  the  business  of  the  owner. 

[SEE    PAR.    99-264-265-272.] 


222  THE    INCOME   TAX 

10. — Depreciation  allowable  on  farm  machinery  but  not  on  tools.  Cost  of 
machinery  is  basis  of  depreciation,  but  is  not  deductible  as  expense.  Cost  of 
ordinary  tools  deductible  as  expense  in  full  in  year  incurred. 

[SEE    PAR.    99-264-265-51.] 

11. — While  Smith  has  a  wife  and  three  children,  only  two  of  his  children 
rthe  two  daughters)  are  under  18  years  of  age.  His  exemption  under  the  new 
law  is,  therefore,  the  $2,000  allowed  a  married  man  living  with  his  wife,  plus 
$200  for  each  dependent  child  under  18  years  of  age,  or  $2,400.  His  exemption 
ander  the  old  law  is  the  $4,000  allowed  a  married  man  living  with  his  wife,  plus 
the  $200  for  each  such  dependent  child,  or  $4,400. 

[SEE    PAR.    4    (SUB.    PAR.    4)    ALSO    PAR.    105-106.] 


A  PHYSICIAN 


Dr.  Robert  Lowe  is  a  practicing  physician.  He  has  a  wife  and  small  son 
with  whom  he  lives  in  a  hotel.  For  more  than  a  year  he  has  resided  in  the 
hotel,  meantime  having  rented  the  family  home  for  $125  a  month  for  more  than 
a  year.  During  1917  he  had  to  repair  plumbing  in  the  house  at  a  cost  of  $250. 

Dr.  Lowe  collected  during  the  year  1917  $15,000  from  the  practice  of  his 
profession.  For  services  rendered  during  the  year  there  remained  outstanding 
accounts  at  the  end  of  the  year  to  the  amount  of  $1,840. 

Having  been  advised  of  a  supposed  realty  bargain,  the  doctor  in  March, 
1917,  purchased  some  lots  in  a  townsite  on  a  projected  railroad  extension,  pay- 
ing for  the  lots  $5,000,  but  by  October  the  railroad  had  changed  its  plans  and  the 
boom  had  collapsed,  so  the  doctor  was  glad  to  sell  his  lots  for  $500 — at  a  loss  of 
$4,500. 

He  owns  two  automobiles — one  for  the  use  of  Mrs.  Lowe  and  for  his  own 
personal  use,  and  the  other  a  roadster  used  exclusively  in  his  practice.  His 
garage  bill  for  the  two  cars  during  1917  was  $30  a  month.  He  used  $500  worth 
of  tires,  gasoline,  oil  and  sundry  supplies  on  his  roadster  and  $300  worth  on  his 
family  car.  He  paid  $60  a  month  rent  for  his  offices,  $75  a  month  for  an  office 
nurse  and  $75  a  month  for  a  chauffeur  for  his  wife.  His  hotel  bill  for  the  year 
was  $2,400  and  the  other  bills  paid  for  clothing  and  entertainment  amounted  to 
$1,000.  During  the  year  he  spent  $500  for  surgical  instruments.  His  local  taxes 
for  the  year  were  $210  and  his  Federal  income  tax,  paid  in  June,  1917  on  income 
for  the  year  1916,  amounted  to  $84.  He  keeps  a  number  of  periodicals  in  his 
waiting  room,  and  paid  in  subscriptions  to  them  for  the  year  $24. 

How  would  Dr.  Lowe  prepare  his  return  for  1917? 


ANSWER 


Dr.  Lowe's  returnable  gross  income  would  consist  of: 
The  $15,000  collected  from  his  practice.     (Note  1,  below) 
The  $125  a  month  rent  from  the  family  home.     (Note  2,  below) 

His  allowable  deductions  would  be: 
That  part  of  garage  bill  and  that  part  of  cost  of  automobile  supplies  applicable 

to  the  roadster  car  used  in  connection  with  the  practice  of  his  profession. 

(Note  3,  below) 
The  $60  a  month  office  rent. 
The  $75  a  month  paid  his  office  nurse. 
The  $24  paid  in  subscriptions  to  periodicals  for  his  office. 
The  $250  spent  in  repairing  plumbing  of  family  home.     (Note  4.  below) 
Local  taxes  to  amount  of  $210. 


THE    INCOME   TAX  223 

Dr.  Lowe's  net  income  would  be  ascertained  by  subtracting  the  total  of  his 
allowable  deductions  from  the  total  gross  income.  He  would  then  be  allowed  a 
credit  against  such  net  income  of  the  amount  of  Excess  Profits  tax,  if  any, 
assessed  for  the  year  1917.  This  would  be  done  before  assessment  of  income 
tax. 

[SEE    PAR.    103    AND    PAR.    1    AND    PAR.    4    (COMPLETE).] 


Dr.  Lowe's  exemption  under  the  new  law  is  $2,200  and  under  the  old  law 
$4,200.     (Note  5,  below) 


His  tax  would  be  computed    as    stated    in    the    example    of    "A    LAWYER- 
POLITICIAN." 


The  following  expenditures  by  Dr.  Lowe  during  1917  were  personal,  living 
or  family  expenses  and  not  deductible:  That  part  of  garage  bill  and  cost  of 
supplies  applicable  to  automobile  used  by  his  family;  $75  a  month  paid  chauf- 
feur to  drive  for  Mrs.  Lowe;  hotel  bill  of  $2,400;  clothing  and  entertainment  bills 
amounting  to  $1,000. 


Notes 

1. — He  need  return  only  the  amount  received  during  the  year.  The  out- 
standing accounts  left  over  and  amounting  to  $1,840  can  be  returned  as  income 
for  the  next  year  if  collected. 

[SEE    PAR.    15.] 

2. — When  the  family  home  was  rented,  it  ceased  to  be  the  dwelling  of  the 
taxpayer  and  became  a  business  property. 

3. — The  automobile  used  by  the  doctor  in  his  practice  is  business  property 
and  the  cost  of  its  care  and  maintenance  is  allowable  as  a  business  expense. 

[SEE    PAR.    68.] 

4. — The  family  home  having  been  converted  into  a  business  property  and 
no  longer  being  the  dwelling  of  the  taxpayer,  the  cost  of  ordinary  repairs  on  it 
to  keep  it  in  habitable  condition  is  allowable  as  a  business  expense. 

[SEE    PAR.   72.] 

5. — Dr.  Lowe  is  married,  lives  with  his  wife  and  has  one  small  son. 

[SEE    PAR.    4    (SUB.    PAR.    4)    ALSO    PAR.    105-106.] 

6.— The  $4,500  loss  on  townsite  lots  is  not  allowable,  according  to  the 
Treasury  Department.  Dr.  Lowe  is  not  a  dealer  in  real  estate,  and  so  the  De- 
partment would  not  allow  him  to  deduct  the  loss  or  any  part  of  the  loss  when 
lie  made  no  profit  from  a  similar  transaction  in  1917. 

[SEE    PAR.    90-92-93-94.] 

7. — The  $500  spent  for  surgical  instruments  represented  an  investment  in 
business  equipment. 

[SEE    PAR.    72.] 

8. — Dr.  Lowe  could  also  claim  as  a  deduction  a  reasonable  allowance  for  tha 
depreciation  of  the  automobile  used  in  his  profession.  In  the  case  of  surgical 
instruments  rendered  obsolete,  he  might  be  entitled  to  a  deduction  on  account 
of  loss. 

[SEE    PAR.    99-264-265-266.] 

9. — His  Federal  income  tax  of  $84  can  not  be  deducted. 

[SEE    PAR.   81.] 


A  WAGE-EARNER 


Martin  Sanders  is  an  expert  machinist  and  is  employed  at  the  Amalgamated 
Iron  Works  at  $5.50  a  day.    Counting  up  on  the  last  payday  of  the  year  he  found 


224  THE    INCOME   TAX 

that  he  had  been  paid  $1,625  in  1917.  He  is  single,  with  no  one  dependent  on 
him  for  support.  He  lives  at  a  boarding-house  at  a  cost  of  $30  a  month.  He 
owns  no  property  and  pays  no  taxes.  He  has  no  debts.  He  has  no  income  other 
than  his  wages.  While  his  wages  have  been  sufficient  to  keep  him  comfortably, 
he  has  managed  to  spend  about  all  he  has  earned.  So  pressed  is  he  for  funds 
at  the  end  of  the  year,  he  must  give  up  a  trip  to  his  old  home  which  would  have 
cost  at  most  only  about  $75. 

Is  Sanders  required  to  file  a  return  of  income  for  the  year  1917, 
and,  if  so,  what  is  his  tax? 


ANSWER 


Sanders'  gross  income  for  1917  was  $1,625. 


He  had  no  allowable  deductions.     (Note  1,  below) 


His  net  income  for  1917  was  therefore  $1,625.     (Note  5,  below) 


His  net  income  having  been  $1,000  or  more  (in  his  case,  more),  he    is    re- 
quired to  file  a  return  of  income.     (Note  6.  below) 

His  exemption  under  the  new  law  is  $1,000.     (Note  2,  below) 


His  taxable  income  was  therefore  the  difference  between  his  total  receipt 
of  income  and  his  exemption,  or  $625. 


His  income  was  not  sufficient  for  assessment  of  Excess  Profits  tax  for  the 
year  1917. 


His  tax  would  be  2  per  cent  of  $625,  or  a  tax  of  $12.50. 

Notes 


1. — All  Sanders'  expenditures  during  1917  were  personal  and  therefore  not 
deductible  in  ascertaining  net  income. 

[SEE    PAR.    69.] 

2. — He  is  single  and  without  dependents.  His  net  income  is  less  than  the 
$3,000  exemption  allowed  by  the  old  law;  hence  he  is  not  concerned  with  that 
exemption. 

[SEE    PAR.   4    AND    PAR.    5    (SUB.-PAR.    3).] 

3. — Sanders  had  practically  no  money  left  at  the  end  of  1917,  yet  he  had  a 
net  income,  as  the  law  defines  the  term  "net  income,"  of  $1,625,  of  which  amount 
$625,  the  amount  in  excess  of  his  specific  exemption  of  $1,000,  is  subject  to  in- 
come tax  for  1917. 

4. — The  Amalgamated  Iron  Works  will  be  required  to  report  the  payment  of 
$1,625  to  Sanders  in  1917  and  give  his  name  and  address.  If  Sanders  does  not. 
therefore,  file  a  return  of  income  not  later  than  March  1,  1918  he  will  be  liable 
to  penalty  when  later  the  officers  of  the  Government  call  upon  him  for  an  ex- 
planation as  a  result  of  the  report  filed  by  his  employer. 

[SEE    PAR.    158    (SUB.-PAR.    5)    AND    CHAP.    VIM.] 

5. — Net  income  is  the  difference  between  gross  income  and  allowable  deduc- 
tions. The  specific  exemption  is  not  considered  in  ascertaining  net  income. 

[SEE    PAR.    1.] 


THE    INCOME   TAX  225 

6. — Every  single  person,  who  is  a  citizen  or  resident  of  the  United  States,  is 
required  to  file  a  return  under  the  new  law  if  his  net  income  is  $1,000  or  more 
for  the  year. 

[SEE    PAR.    112.] 


A  MILLIONAIRE 


John  Templeton  is  worth  millions  of  dollars.  He  is  recognized  as  a  multi- 
millionaire. He  resides  in  a  palatial  home  surrounded  by  acres  of  garden.  He 
entertains  with  a  lavish  disregard  of  cost.  He  owns  vast  tracts  of  city  and 
suburban  lands,  and  late  in  the  year  1916  succeeded  in  gaining  control  of  an 
elaborate  street  railway  system.  During  1917  he  extended  the  lines  of  this 
system  into  his  suburban  lands  and  has  been  subdividing,  improving  and  parking 
the  properties  with  the  purpose  of  selling  at  large  profits.  That  he  will  realize 
the  expected  profits  seems  assured. 

Templeton  is  a  widower.  With  him  reside  his  son,  28  years  of  age,  who  is 
associated  with  him  in  business,  and  his  daughter  and  her  husband. 

Late  in  1916,  in  his  fight  to  get  control  of  the  street  railway  system,  Tem- 
pleton's  expenditures  were  so  heavy  that  he  drew  on  his  fortune  for  $3,000,000. 
This  was  cash  and  he  had  to  borrow  $1,000,000  of  it  at  7  per  cent.  On  December 
1,  1917  he  made  his  first  annual  interest  payment  on  this  loan,  paying  at  that 
time  $70,000.  During  1917  he  paid  local  taxes  on  his  real  estate  amounting  to 
$128,510.  From  a  mining  property  in  the  Arizona  copper  section  he  received 
dividends  of  $110,000.  On  Atlantic  Railroad  bonds  paying  5  per  cent,  his  hold- 
ing amounting  to  $600,000  par  value,  he  collected  a  year's  interest  on  December 
1,  1917.  He  had  bought  the  bonds  two  years  before  at  102.  Being  pressed  for 
ready  cash  late  in  1917,  he  sold  half  his  holding  at  the  price  he  had  paid,  receiv- 
ing therefor  $306,000.  From  an  office  building  he  received  during  1917  gross 
rents  of  $124,000.  The  maintenance  of  the  building — janitors,  fuel,  incidental 
repairs  and  elevator  service — cost  $32,000. 

Templeton  at  the  close  of  the  year  was  happy  in  the  prospect  of  big  returns 
from  his  street  railway  and  suburban  land  proposition.  Business  opinion  was 
that  he  had  played  a  shrewd  hand,  with  a  certainty  of  a  material  increase  of  his 
fortune. 

During  the  year  1917  through  his  control  of  the  street  railway  company  he 
had  all  the  earnings  of  the  company  put  into  the  extension  of  its  lines. 

What  kind  of  a  return  of  income  would  Templeton  file  for  1917? 


ANSWER 

Templeton's  returnable  gross  income  would  consist  of: 

Dividends  from  Arizona  mine $110,000 

One  year's  interest  Atlantic  Railroad  bonds  at  5  per  cent 30,000 

Rent  from  office  building 124,000 

Total  returnable  gross  income $264,000 


His  allowable  deductions  would  be: 

Expense  of  maintaining  office  building $  32,000 

Local  taxes 128,510 

Interest  on  $1,000,000  loan 70,000 

Depreciation  office  building  at  2|  per  cent  on  cost  of  $1,300,000     32,500 


Total  allowable  deductions....  $263,010 


Templeton's  net  income  for  the  year  1917  would  be  the  difference 
between  total  gross  income  and  total  allowable  deductions 
($264,000  minus  $263,010) ,  or $990 


226  THE    INCOME   TAX 


Templeton  is  a  single  man. 
[SEE    PAR.   106.] 


His  exemption  under  the  new  law  is  $1,000  and  under  the  old  law  $3,000. 
He  is  single,  being  a  widower,  and  neither  his  son  nor  his  daughter  is  dependent 
upon  him  for  support. 

[SEE    PAR.    4    (SUB.-PAR.    4)    AND    PAR.    105-106.] 


Templeton  is  not  even  required  to  file  a  return  of  income  for  the  year  1917. 
[SEE    PAR.    112.] 

Notes 


1. — He  made  no  profit  from  the  sale  of  half  his  Atlantic  Railroad  bonds, 
having  sold  at  102,  the  price  he  had  paid,  therefore  no  part  of  the  $306,000  re- 
ceived for  the  bonds  should  be  accounted  for  as  income. 

2. — One  purpose  of  this  illustration  is  to  show  how  it  is  income  (net  income) 
and  not  capital,  which  is  subject  to  tax. 


A  SALARIED  MAN 


Walter  Stimson  is  sales  manager  for  the  Western  Steel  Company  at  a  salary 
of  $4,000  a  year.  He  and  his  wife,  there  being  no  children,  live  in  a  cottage 
which  they  have  been  buying  on  the  installment  plan.  On  December  6,  1917  the 
last  payment  of  $500  was  made. 

Pursuant  to  practice,  the  company  paid  Stimson  on  February  12,  1917,  a 
bonus  of  $400  in  recognition  of  his  efficient  service  during  the  year  1916.  Mrs. 
Stimson  had  an  income  of  her  own  of  $50  a  month  in  rent  from  property  in- 
herited by  her  several  years  before. 

Household  expenses  during  the  year  1917  were  $2,400,  club  dues  for  Stimson 
and  his  wife  $120  and  wearing  apparel  $720.  The  two  went  away  for  a  vacation 
in  the  summer  and  on  the  trip  spent  $300. 

In  January,  1917,  Stimson  bought  two  lots  of  mining  stock,  paying  $500  for 
each  lot.  One  lot  he  sold  in  August  for  $200  and  the  other  in  November  for  $300. 
Stimson  paid  local  taxes  for  the  year  amounting  to  $112  and  a  street  improve- 
ment assessment  amounting  to  $64. 

What  is  Stimson's  income  tax  for  1917,  and  how  would  he  make 
the  computation? 


ANSWER 


Stimson's  gross  income  consisted  of: 

His  salary $4,000 

Bonus  received  in  February  (Note  1,  below) 400 

Rent  received  by  wife  (Note  2,  below) 600 

Total  gross  income....  $5,000 


His  allowable  deductions  were: 
Local  taxes.     (Note  3,  below) $    H2 


His  net  income  was: 


Difference  between  $5,000  and  $112  (Note  3,  below) $4,888 


THE   INCOME   TAX  227 

His  net  income  was  not  sufficient  for  assessment  of  Exeess  Profits  tax  for 
1917. 


Stimson's  exemption  was: 
$2,000  under  new  law  and  $4,000  under  old  law.     (Note  4,  below) 


His  net  income  subject  to  tax  was:     (Note  5,  below) 

$2,000  at  2  per  cent,  tax  being $40. 

$888  at  4  per  cent,  tax  being....  ..  35.52 


Total  income  tax....  $75.52 


The  following  expenditures  by  Stimson  were  personal,  living  or  family  ex- 
penses and  not  deductible:  Payment  of  $500  on  purchase  of  home;  household  ex- 
pense of  $2,400;  club  dues  of  $120;  cost  of  wearing  apparel  $720;  Cost  of  sum- 
mer vacation  $300. 


Notes 


1. — A  bonus  received  pursuant  to  practice  and  for  service  rendered  is  not 
a  gift;  it  is  additional  compensation  and  is  to  be  included  in  a  return.  More- 
over, it  should  be  included  in  return  for  the  year  in  which  received,  regardless 
of  when  service  was  rendered. 

[SEE    PAR.    16-225.] 

2. — In  case  of  this  kind  husband  and  wife  should  make  joint  return.  This 
return  must  include  income  of  both.  It  is  not  necessary,  however,  that  both 
sign  the  return.  The  husband's  signature  is  sufficient.  If  the  net  income  of 
both  husband  and  wife  is  in  excess  of  $5,000,  separate  returns  should  be  made 
by  them  and  attached  when  filed.  The  reason  for  this  is  that  the  income  of  each 
individual  is  considered  by  itself  in  assessing  the  additional  tax  applicable  to  all 
net  income  in  excess  of  $5,000. 

[SEE    PAR.    303.] 

3. — Stimson's  payment  of  $64  as  a  street  improvement  assessment  is  not 
deductible.  It  is  a  tax  "assessed  against  a  local  benefit." 

[SEE    PAR.    81-82.] 

4. — Stimson  is  married  and  lives  with  his  wife.  They  have  no  children  and, 
presumably,  no  others  dependent  upon  them  for  support. 

[SEE    PAR.   4    (SUB.-PAR.   4)    AND    PAR.    105-106.] 

5. — The  new  law  rate  of  2  per  cent  applies  to  net  income  between  the 
amount  of  the  new  law  exemption  and  the  amount  of  the  old  law  exemption. 
The  combined  rates  of  the  old  and  new  laws  apply  to  net  income  in  excess  of 
the  old  law  exemption. 

[SEE    PAR.    4    (SUB.-PAR.    5).] 

6. — Stimson  can  not,  according  to  the  Treasury  Department,  deduct  his 
'losses  on  mining  stock. 

[SEE  PAR.    90-92-93-94.] 

7. — Stimson  has  probably  filed  returns  in  other  years.  If  he  has  not,  he 
should  file  one  for  the  year  1917.  The  Government  will  learn  of  the  payment 
made  to  him  by  the  Western  Steel  Company  and  at  the  same  time  get  his  name 
and  address.  If  he  does  not  file  a  return  not  later  than  March  1,  1918,  he  will  be 
called  upon  to  explain  and  will  then  be  liable  to  penalty. 

[SEE    PAR.    158    (SUB.-PAR.    5)    AND    CHAP.    VIM.] 


A  MERCHANT 


Isidor  Kurtzman  has  a  clothing  store.     He  is  not  living  with  his  wife.     He 
lives  at  his   club  and   his  wife  in  an   apartment   of  her  own.     They  are   not 


228  THE    INCOME   TAX 

divorced,  but  he  pays  her  $150  a  month  separate  maintenance.     They  have  no 
children. 

Kurtzman's  store  stock  inventoried  at  the  end  of  the  year  1916  at  $64,000, 
cost.  During  the  year  1917  he  made  purchases  of  merchandise  to  the  amount  of 
$165,000  and  his  sales  during  the  year  totaled  $213,000.  His  inventory  at  the 
end  of  1917,  taken  at  cost,  showed  stock  on  hand  of  $68,000.  For  rent,  clerk 
hire  and  sundry  store  expenses  he  paid  out  $10,000.  His  total  payments  for 
taxes  amounted  to  $680,  included  in  the  amount  being  a  Twin  Peaks  Tunnel 
assessment  of  $110  paid  in  San  Francisco  and  a  Federal  income  tax  paid  in 
June,  1917,  of  $78.  He  also  wrote  off  accounts  due  to  the  amount  of  $1,100,  hav- 
ing made  every  possible  effort  to  collect  them.  During  the  year  he  paid  a  bank 
interest  to  the  amount  of  $600. 

How  would  Kurtzman  prepare  his  return  for  1917? 


ANSWER 


Kurtzman's  gross  income  would  be  ascertained  as  follows: 

Sales    during   1917 $213,000 

Stock  on  hand  at  close  of  1917  (cost) 68,000 


$281,000 

Purchases  during  1917 $165,000 

Stock  on  hand  at  close  of  1916  (cost) 64,000 


$229,000 
Gross  income  from  store.--  $  52,000 


His  allowable  deductions  would  be: 
The  $10,000  paid  for  rent,  clerk  hire  and  sundries. 
Also  $492  of  his  taxes.     (Note  1,  below) 
The  $600  interest  paid  bank. 
The  $1,100  in  bad  debts  charged  off.     (Note  2,  below) 


Kurtzman's  net  income  would  be  ascertained  by  subtracting  the  toal  of  his 
deductions  from  his  gross  income.  He  would  then  be  allowed  a  credit  against 
such  net  income  of  the  amount  of  Excess  Profits  tax,  if  any,  assessed  for  the 
year  1917.  This  would  be  done  before  assessment  of  income  tax. 

[SEE    PAR.    1-103.] 


Kurtzman's  exemption  is  $1,000  under  the  new  law  and  $3,000  under  the  old 
law.     (Note  3,  below) 


The  following  expenditures  by  Kurtzman  were  of  personal,  living  or  family 
character  and  not  deductible  in  his  return:  His  own  living  expenses  at  his 
club;  the  $150  a  month  separate  maintenance  paid  his  wife. 

[SEE    PAR.    69-44.] 


The  $110    paid    as    Twin    Peaks    Tunnel    assessment  was  a  tax  "assessed 
against  a  local  benefit"  and  therefore  not  deductible. 
[SEE    PAR.    81-82.] 


The  $78  Federal  income  tax  paid  in  1917  it  not  deductible. 
[SEE    PAR.   81.] 


THE    INCOME   TAX  229 

Notes 


1. — Of  Kurtzman's  total  expenditure  for  taxes,  two  items  are  not  allowable 
— Twin  Peaks  Tunnel  assessment  and  Federal  income  tax. 

[SEE    PAR.    81-82.] 

2. — Bad  debts  are  allowable  as  a  deduction  for  the  year  in  which  ascer- 
tained as  worthless  and  charged  off. 

[SEE    PAR.    98.] 

3. — Although  married,  Kurtzman  and  his  wife  do  not  live  together.  The 
tact  that  he  supports  his  wife  in  separate  maintenance  makes  no  difference. 
He  has  no  one  else  dependent  upon  him  for  support.  He  is  not,  therefore,  the 
head  of  a  family.  His  status  for  income  tax  purposes  is  strictly  that  of  a  single 
man  without  dependents. 

[SEE    PAR.    4    (SUB.-PAR.    4)    ALSO    PAR.    105-106-107.] 


A  RETIRED  MAN 
OWNING  "TAX-FREE"  BONDS 


Philip  Klein  has  retired  from  active  business  but  retains  his  investments 
in  various  properties  and  his  interest  in  a  partnership  conducting  a  jewelry 
business.  With  him  live  his  wife  and  an  invalid  brother,  who  is  dependent  upon 
him  for  support. 

The  jewelry  partnership  closed  its  books  on  December  31,  1917.  It  did  not, 
however,  make  a  distribution  of  its  earnings,  no  one  of  the  partners  being  in 
need  of  money.  The  books  of  the  partnership  showed  net  earnings  for  the 
year  ending  December  31  amounting  to  $75,000.  There  are  three  partners,  with 
equal  interests. 

Klein  has  $20,000,  par  value,  in  Central  Power  Company  bonds,  paying  6 
per  cent  and  guaranteed  "tax-free,"  and  $30,000  in  Inter-cities  Electric  Railway 
bonds  paying  6  per  cent  and  not  guaranteed  against  deduction  for  taxes.  He 
received  during  the  year  1917  $210,000  in  dividends  from  a  tungsten  property 
operated  by  a  corporation.  He  does  not  maintain  an  office,  but  keeps  up  his 
business  connections,  which  are  not  active,  from  his  residence  and  his  club. 
He  does,  however,,  employ  a  secretary  whom  he  pays  $1,800  a  year.  Having 
accumulated  a  fortune,  he  responded  generously  to  the  war  call  of  the  Red 
Cross,  Young  Men's  Christian  Association  and  Knights  of  Columbus  during  the 
year,  giving  to  each  organization  $30,000. 

His  local  taxes  were  $6,400  and  his  Federal  Income  tax  $1,250,  paid  in  1917. 
He  paid  no  interest.  His  only  other  expenses  were  those  of  his  household. 

How  should  he  collect  his  bond  interest? 

Also  how  would  he  prepare  his  income  tax  return  for  1917? 


ANSWER 


Klein's  returnable  gross  income  for  1917  would  consist  of: 
$25,000  from  jewelry  partnership  (Note  1,  below) 
Interest  at  6%  on  $20,000  Central  Power  bonds.     (Note  4,  below) 
Interest  at  6%  on  $30,000  Electric  Railway  bonds. 
$210,000  in  tungsten  dividends.     (Note  2,  below) 


230  THE   INCOME   TAX 

His  allowable  deductions  would  be: 
$1,800  paid  secretary  during  year. 
$6,400  local  taxes. 
Only  $34,470  of  the  total  amount  of  $90,000  given  during  the  year  to  the  Red 

Cross,  Y.  M.  C.  A.  and  K.  of  C.     (Note  3,  below) 


Klein's  net  income  would  be  ascertained  by  subtracting  the  total  of  his 
allowable  deductions  from  the  total  of  his  gross  income.  He  would  then  be 
allowed  a  credit  against  such  net  income  of  the  amount  of  Excess  Profits  tax 
assessed  for  1917.  He  would  next  be  allowed  a  second  credit  for  one-third  of 
the  Excess  Profits  tax  assessed  against  the  jewelry  partnership.  These  two 
credits  would  be  taken  before  assessment  of  income  tax.  From  the  amount  of 
net  income  remaining,  after  the  allowance  of  the  two  Excess  Profits  credits, 
there  should  be  deducted  the  $210,000  in  dividends.  Then,  on  the  amount  re- 
maining after  that  deduction,  if  any  in  excess  of  $2,000,  should  be  computed  the 
normal  income  tax;  only  so  much,  however,  as  might  be  in  excess  of  $2,000 
would  be  subject  to  such  normal  tax  computation. 

[SEE    PAR.    1-103-104    AND    PAR.   4    (COMPLETE).] 


The  amount  of  net  income  subject  to  the  additional  tax  would  be  the 
amount  shown  by  the  return  (difference  between  gross  insome  and  allowable 
deductions)  less  the  two  Excess  Profits  Tax  credits — that  is,  without  deducting 
the  $210,000  in  dividends. 

[SEE    PAR.    4    (SUB.-PAR.    7)    ALSO    PAR.    104-306.] 


Klein's  exemption  is  $2,000  under  the  new  law  and  $4,000  under  the  old 
law.    (Note  5,  below) 


The  following  expenditures  by  Klein  during  1917  were  personal,  living  or 
family  expenses  and  are  not  deductible:  All  the  expenses  of  his  household 
and  all  personal  expenses  for  himself,  his  wife  and  his  invalid  brother. 

[SEE    PAR.    69.] 


Notes 


1. — The  law  requires  that  each  partner  include  in  his  individual  income  tax 
return  his  share  of  the  net  earnings  of  a  partnership,  whether  such  earnings 
have  been  distributed  or  not.  A  partner's  share  is  returnable  when  it  has  been 
ascertained. 

[SEE    PAR.   57-140.] 

2. — Klein  must  include  his  dividends  in  his  statement  of  gross  income  but, 
as  explained  above,  is  allowed  to  deduct  them  from  net  income  for  the  purpose 
of  the  normal  income  tax.  Such  dividends,  however,  go  back  into  the  computa- 
tion for  the  purpose  of  the  additional  income  tax,  as  also  explained  above. 

[SEE    PAR.    104-306.] 

3. — Klein's  gross  income  for  1917  was  $238,000.  Without  considering  any 
part  of  his  donations  to  charitable  and  religious  organizations,  (that  is,  by  de- 
ducting only  the  $1,800  paid  his  secretary  and  the  $6,400  local  taxes)  his  net 
income  would  be  $229,800.  Taking  15  per  cent  of  $229,800,  we  have  $34,470. 
This  amount  ($34,470)  is  the  limit  imposed  by  law  upon  Klein's  deduction  of 
donations  to  the  Red  Cross,  Y.  M.  C.  A.  and  K.  of  C. 

[SEE    PAR.    101.] 

4. — Klein  signed  ownership  certificates  claiming  exemption  when  he  col- 
lected his  interest  on  his  Central  Power  bonds,  with  the  result  that  he  must 
account  for  the  interest  as  income  which  has  not  been  taxed  at  the  source, 
Klein  must  pay  the  tax;  the  Government  will  not  look  to  the  Central  Power 
Company.  That  corporation  has  already  sent  in  Klein's  ownership  certificates 
claiming  exemption  and  has  thereby  been  relieved  of  liability  for  the  tax  at 
the  source.  Klein  must  pay  the  tax  despite  the  guaranty  in  the  bonds.  On  the 


THE    INCOME   TAX  231 

other  hand  had  Klein  signed  ownership  certificates  in  which  he  did  not  claim 
exemption,  he  could  enter  the  interest  in  his  return  as  having  been  taxed  at 
the  source  and  get  credit  to  that  extent  for  the  normal  tax  computation.  With- 
out ownership  certificates  claiming  exemption,  the  Central  Power  Company 
would  have  to  pay  the  tax  to  the  Government. 

[SEE    PAR.    148-304.] 

5. — Klein  is  married  and  lives  with  his  wife.  The  fact  that  he  supports  an 
invalid  brother  does  not  give  him  the  additional  exemption  of  $200.  The  addi- 
tional exemption  is  allowed  only  for  dependent  children  of  the  taxpayer. 

[SEE    PAR.   4    (SUB.-PAR.    4)    ALSO    PAR.    105-106.] 

6. — Klein  is  not  allowed  deduction  for  his  Federal  income  tax  of  $1,250,  paid 
in  1917  on  income  for  1916. 

[SEE    PAR.   81.] 

7. — Klein  can  not  deduct  in  his  return  any  of  the  expenses  of  the  jewelry 
partnership.  Such  expenses  were  covered  when  the  partnership  determined  its 
net  earnings,  a  third  of  which  net  earnings  became  an  item  of  Klein's  gross  in- 
come. 

[SEE    PAR.   70.] 


A  LAWYER-POLITICIAN 


Barclay  Emerson  is  a  lawyer  in  active  practice.  He  is  a  bachelor.  During 
the  year  1917  he  received  in  fees  and  retainers  $42,000.  Of  this  amount,  how- 
ever, $2,000  was  for  an  old  case  ended  five  years  before.  He  had  come  to  the 
conclusion  that  this  would  never  be  paid,  but  had  left  the  account  open  on  his 
books.  His  client  had  been  his  personal  friend  and  for  that  reason  he  had  not 
pressed  the  matter.  His  only  other  income  during  the  year  consisted  of  $600  in 
interest  on  Western  Railway  Company  bonds. 

He  employed  a  stenographer  at  $90  and  a  law  clerk  at  $125  a  month  during 
the  entire  year.  His  rent  was  $75  a  month.  He  bought  $250  worth  of  law 
books.  Having  prospered  during  the  year,  he  made  a  sister  a  Christmas  pres- 
ent of  $500  and  at  the  same  time  gave  to  the  Associated  Charities  $100. 

In  the  summer  of  1917  he  thought  the  interests  of  the  public  demanded  that 
he  enter  public  life,  and  so  he  made  the  race  for  Supervisor  of  San  Francisco 
that  fall.  He  spent  $1,500  of  his  own  money  in  the  campaign,  to  say  nothing 
of  what  others  spent,  but  the  public  did  not  seem  to  agree  with  him  and  he 
was  defeated. 

How  would  Emerson  prepare  his  return  for  1917? 


ANSWER 


Emerson's  gross  income  for  1917  was: 
Total  retainers  and  fees  received  during  1917  to  amount  of  $42,000.     (Note  1, 

below) 
The  $600  in  interest  on  Western  Railway  bonds.     (Note  4,  below) 


His  allowable  deductions  were: 
The  $90  a  month  paid  stenographer. 
The  $125  a  month  paid  law  clerk. 
The  $75  a  month  rent. 
Donation  of  $100  to  Associated  Charities.     (Note  2,  below) 


232  THE    INCOME   TAX 

Emerson's  net  income  would  then  be  ascertained  by  subtracting  the  total 
of  his  allowable  deductions  from  the  total  of  his  gross  income.  He  would  then 
be  allowed  a  credit  against  such  net  income  of  the  amount  of  Excess  Profits 
tax  assessed  for  the  year  1-917.  This  would  be  done  before  the  assessment  of 
income  tax. 

[SEE    PAR.    103    AND    PAR.    4    (COMPLETE).] 


Emerson's  exemption  is  $1,000  under  the  new  law  and  $3,000  under  the  old 
law.     (Note  3,  below) 


His  normal  tax  liability  would  be  determined  as  follows: 

(a)  Deduct  from  net  income  amount  of  Excess  Profits  tax  assessed  for 
1917. 

(b)  On    amount   of    net    income  remaining  figure  normal  tax — 2%  on 
$2,000  between  new  law  exemption  of  $1,000  and  old  law  exemption 
of  $3,000;   then  4%    on  amount    exceeding    old    law    exemption  of 
$3,000. 


Emerson's  additional  tax  would  then  be  determined  by  subjecting  to  the 
rates  of  the  new  and  old  law  the  amount  of  net  income  as  shown  by  the  differ- 
once  between  gross  income  and  deductions  (less  Excess  Profits  tax)  in  excess 
of  $5,000. 

[SEE    PAR.    4    (SUB.-PAR.  7)    ALSO    PAR.    104-306.] 


The  following  expenditures  by  Emerson  were  for  personal  or  living  ex- 
penses and  cannot  be  deducted:  Any  living  expenses  for  the  year,,  and  his 
political  campaign  expense  of  $1,500.  (Note  5,  below) 


Notes 


1. — The  $2,000  fee  earned  years  before  but  not  paid  until  1917  must  be  re- 
turned as  income  belonging  to  1917. 

[SEE    PAR.    15.] 

2. — This  donation  is  allowable  because  made  to  a  charitable  organization 
and  not  in  excess  of  15  per  cent  of  what  Emerson's  net  income  would  be  without 
deducting  it.  The  $500  Christmas  gift  to  his  sister  is  not  deductible,  for  the 
reason  that  it  is  a  gift  and  was  not  made  to  a  charitable,  religious  or  educational 
organization  or  a  society  for  prevention  of  cruelty  to  children  or  animals. 

[SEE    PAR.    101.] 

3. — Emerson  is  single  and  has  no  dependents. 

4. — The  Western  Railway  bonds  are  not  "tax-free"  and  there  was  no  decluc- 

[SEE    PAR.    148.] 
tion  of  tax  at  the  source. 

5. — Such  a  political  expense  is  not  a  necessary  expense  of  Emerson's  busi- 

[SEE    PAR.    68.] 
ness. 

6. — The  $250  spent  in  buying  law  books  was  an  investment  in  business 
equipment,  and  not  deductible. 

[SEE    PAR.   72.] 


STOCKHOLDER  OF  A  BANK 


Howard  Carson  owns  100  shares,  par  value  $100  a  share,  of  the  Western 
Banking  and  Trust  Company.  He  is  making  up  his  income  tax  return  for  the 
year  1917  and  has  it  almost  completed.  He  has  not,  however,  made  entry  of  the 
amount  received  during  the  year  as  a  dividend  on  the  stock  of  the  bank.  He 


THE    INCOME   TAX  233 

is  just  about  to  do  so  when  he  recalls  that  some  time  back  he  received  a  little 
printed  slip  from  the  bank,  notifying  him  that  the  bank  had  paid  to  the  State 
of  California  a  tax  assessed  against  the  capital  stock  of  the  bank  and  amount- 
ing to  $1.05  a  share.  He  did  not  pay  much  attention  to  the  slip  at  the  time  but 
finally  locates  it.  His  dividend  from  the  bank  during  the  year,  received  in 
actual  cash,  totaled  $800. 

What  should  he  do  in  making  up  his  return? 


ANSWER 


Carson  should  add  $105  to  the  amount  of  his  deduction  for  taxes  paid  dur- 
ing 1917  in  his  own  return. 

Then  he  should  add  $105  to  the  amount  of  his  bank  dividend — that  is,  in- 
crease the  amount  of  the  dividend  from  $800  to  $905 — and  enter  the  dividend 
in  his  return  at  $905. 

The  Government  holds  that  the  payment  of  the  tax  by  the  bank  on  the 
shares  owned  by  Carson  is  merely  an  accomodation  extended  the  stockholder; 
that  the  bank  cannot  deduct  the  tax  in  its  return  but  that  the  stockholder  can, 
according  to  the  number  of  shares  he  owns.  But  if  the  bank  had  not  been  re- 
quired to  pay  a  tax  of  $105  on  Carson's  shares  it  could  have  paid  him  $905 
instead  of  $800  as  a  dividend;  therefore,  Carson  must  add  the  $105  to  his  divi- 
dend. 

[SEE    PAR.    30-84 — ALSO    PAGE    135.] 


A  HOLDING  COMPANY 


The  Nevada  Silver  Company  operates  a  highly  productive  mining  property 
and  declared  and  paid  dividends  to  the  amount  of  $800,000  during  the  year  1917. 
Such  dividend  payments  did  not,  however,  represent  all  its  net  earnings  for  the 
year,  a  portion  having  been  added  to  surplus.  The  company  early  in  January, 
1918,  makes  an  income  tax  return  showing  a  net  income  for  1917  of  consider- 
ably over  a  million  dollars. 

A  stock-holding  company,  known  as  the  Nevada  Company,  has  been  or- 
ganized and  is  being  maintained.  Its  income  consists  entirely  of  the  dividends 
paid  by  the  Nevada  Silver  Company.  Its  expenses  are  inconsiderable.  Assume, 
for  the  purpose  of  this  example,  that  they  are  nothing. 

The  entire  gross  income  of  the  Nevada  Company,  as  a  part  of  the  net  in- 
come of  the  Nevada  Silver  Company,  must  bear  the  income  tax  in  the  assess- 
ment against  the  Nevada  Silver  Company — the  2  per  cent  of  the  old  law  and 
the  4  per  cent  of  the  new  law. 

Must  this  income  (which  is,  for  all  practical  purposes,  both  the 
gross  and  the  net  income  of  the  holding  company)  again  be  taxed  6 
per  cent  in  an  assessment  against  the  Nevada  Company  in  view  of  the 
requirement  of  the  law  that  every  corporation  maintaining  a  cor- 
porate existence  must  make  a  return? 


ANSWER 


Prior  to  enactment  of  the  law  of  October  8,  1917,  the  Nevada  Company 
would  have  been  required  to  pay  the  full  income  tax  on  its  own  net  income.  Its 
net  income  being  the  same  as  its  gross  income,  and  its  gross  income  having 


234  THE   INCOME   TAX 

come  directly  from  subjection  to  the  full  income  tax  in  the  assessment  against 
the  net  income  of  the  Nevada  Silver  Company,  there  was  a  double  taxing  of  the 
income  from  the  mining  property  in  its  passage  to  the  real  parties  at  interest, 
the  stockholders  of  the  Nevada  Company  (the  holding  company). 

In  the  Act  of  October  3,  1917  partial  relief  has  been  provided. 

The  Nevada  Company  must,  as  usual,  file  a  return  and  account  for  the 
dividends  it  received  from  the  Nevada  Silver  Company  during  1917.  There  is 
no  relaxation  of  requirements  in  this  respect. 

But  the  double  taxing  is  enforced  only  to  the  extent  of  the  2  per  cent  rate 
of  the  old  law.  The  Nevada  Company  is  allowed  a  credit  for  the  amount  of 
dividends  received  from  the  Nevada  Silver  Company  as  far  as  the  4  per  cent 
rate  of  the  new  law  is  concerned.  Such  credit  would  wipe  out  its  net  income 
and  the  Nevada  Company  would  not  have  the  4  per  cent  rate  to  pay. 

[SEE    PAR.    176-184    AND    PAR.    6    (COMPLETE).] 


THE    EXCESS    PROFITS    TAX  235 


CHAPTER  XXVI 


EXCESS  PROFITS  TAX 


[Note  : — Congress  will  be  asked  at  its  approaching  session,  begin- 
ning .in  December,  to  amend  the  Excess  Profits  Tax  law  in  a  number 
of  particulars.  What  will  be  the  response  can  not  be  foretold.  Certain- 
ly, however,  the  law  ought  to  be  amended  for  the  sake  of  simple  equity 
and  justice.  In  the  event  of  amendment,  changes  made  necessary  in 
the  ensuing  chapter  will  be  covered  by  a  supplement.] 


The  Excess  Profits  Tax,  imposed  by  the  War  Revenue  law,  Act 
of  October  3,  1917,  is  a  tax  in  addition  to  all  other  taxes  imposed  by 
Federal  laws. 

The  language  of  the  law  is  admittedly  clouded  and  ambiguous — 
so  vague,  indeed,  that  at  the  time  this  book  went  to  press  no  attempt 
had  been  made  by  the  Treasury  Department  to  interpret  it.  In  fact 
the  Department  was  at  that  time  declining  to  answer  questions  re- 
garding the  meaning  of  the  law  and  had  even,  by  blanket  order,  ex- 
tended until  January  1,  1918,  the  time  for  filing  Excess  Profits  Tax 
returns  required  in  connection  with  Income  Tax  returns  for  fiscal 
years  ending  more  than  60  days  prior  to  the  end  of  the  calendar 
vear  1917.  And  meantime  the  Secretary  of  the  Treasury  had  an- 
nounced that  he  would  summon  to  Washington  several  of  the  fore- 
most lawyers  and  business  experts  of  the  nation  to  serve  on  a  board 
of  interpretation.  With  its  meaning  thus  obscured,  Congress  turned 
the  law  over  to  the  Treasury  Department  for  enforcement  and  the 
result  is  almost  sure  to  be  a  continuous  changing,  shifting  and  re- 
versal of  interpretation  during  the  early  part  of  1918.  That  is  what 
transpired  when  the  first  Income  Tax  law  of  1913  went  into  effect, 
and  the  chances  are  a  hundred  to  one  that  the  taxpaying  public  will 
have  the  same  experience  in  connection  with  the  Excess  Profits  Tax 
law. 


236  THE    EXCESS    PROFITS    TAX 

Obviously  it  was  the  intent  of  Congress  to  impose  this  tax  upon 
profits  of  the  war  years,  beginning  with  1917,  in  excess  of  those 
earned  during  the  three  years — 1911,  1912  and  1913 — immediately  pre- 
ceding the  year  1914,  in  which  the  great  world  war  began. 

There  are  three  basic  considerations  involved  in  the  computation 
of  this  tax.  The  first  is  net  income  as  ascertained  for  Income  Tax 
purposes ;  the  second  is  the  return  from  invested  capital  in  the  pre- 
dar  period;  the  third  is  the  return  from  invested  capital  in  1917  and 
subsequent  years.  Such  is  the  general  scheme  proposed  by  Congress 
for  taxing  abnormal  profits  realized  in  1917  and  subsequent  years, 
but  the  law  reaches  out  much  farther.  It  does  not  stop  with  the 
taxing  of  war  profits ;  its  application  is  not  restricted  to  business 
benefited  by  the  war ;  it  is  not  balked  even  by  a  lack  of  invested  capi- 
tal. It  covers  the  income  from  trades  and  professions  in  excess  of 
certain  specified  amounts  and  becomes,  in  plain  reality,  still  another 
tax  upon  income.  Thus  the  scheme  of  assessment  belies  both  the 
title  of  the  law  and  the  evident  intent  of  Congress. 

But  notwithstanding  that  the  method  of  computation  and  assess- 
ment prescribed  is  not  only  clumsy  and  awkward  but  also  unscientific, 
it  is  believed  that,  from  experience  in  administering  the  Income  Tax 
and  other  involved  Federal  revenue  statutes,  an  interpretation  of  the 
law  can  be  given  and  instructions  for  compliance  with  it  offered 
which  can  be  safely  followed. 

In  the  chapters  on  Income  Tax  the  principal  basis  of  computation 
has  been  thoroughly  explained  and  illustrated. 

387.— THOSE  AFFECTED. 

With  certain  exemptions  as  to  character  of  business  and  certain 
exceptions  with  respect  to  amount  of  income,  hereinafter  explained, 
the  Excess  Profits  Tax  is  applicable  to : 

(a)  Individuals,    who    are    citizens    or    residents    of    the    United 
States. 

(b)  Individuals  who  are  non-resident  aliens. 

(c)  Partnerships,  both  domestic  and  foreign. 

(d)  Corporations,  both  domestic  and  foreign. 

388.— THOSE  EXEMPT. 

Specifically  exempted  from  the  application  of  this  Excess  Profits 
Tax  are : 

(a)  Any  corporation  exempt  under  the  Income  Tax  law.     (For 
complete  list  see  chapter  headed  "Corporations  Exempt.") 


THE    EXCESS    PROFITS    TAX  237 

(b)  Any  partnership  engaged  in  the  same  character  of  business 
as  any  one  of  the  corporations  just  referred  to. 

(c)  Any  individual  engaged  in  the  same  character  of  business  as 
any  one  of  the  corporations  just  referred  to. 

(d)  Officers  or  employees  of  the  United  States,  or  of  any  State, 
territory  or  the  District  of  Columbia,  or  any  local  sub-divi- 
sion of  a  State  or  territory,  as  far  as  their  official  compensa- 
tion is  concerned,  but  no  farther. 

389.— ALL  OTHERS  AFFECTED. 

Any  individual,  partnership  or  corporation,  unable  to  qualify  for 
exemption  under  one  of  the  above  provisions  and  in  receipt  of  a  net 
income  in  excess  of  the  deduction,  hereinafter  explained,  is  affected 
by  the  Excess  Profits  Tax. 

390.— PARTNERSHIPS  TAXED. 

One  point  of  significance  is  that  a  partnership  is  taxed  under  the 
Excess  Profits  Tax  schedule.  A  partnership  is  not  subject  to  Income 
Tax  (either  ordinary  or  war)  but,  as  a  taxable  entity,  comes  under 
the  Excess  Profits  Tax  schedule.  A  partnership  will,  therefore,  have 
to  be  prepared  to  file  a  return  showing  its  net  income  and  its  invested 
capital,  not  only  for  the  year  1917,  but  also  for  the  years  1911,  1912 
and  1913,  or  for  all  of  such  years  as  it  was  in  existence  the  entire 
year.  This  return  will  be  used  by  the  Government  as  a  basis  of  as- 
sessment of  the  Excess  Profits  Tax. 

391.— INDIVIDUALS  REGARDLESS 
OF  KIND  OF  BUSINESS. 

Another  point  of  significance  is  that  all  individuals  who  can  not 
qualify  for  exemption,  as  explained  above,  and  whose  income  is  suf- 
ficient to  make  them  liable,  as  hereinafter  explained,  are  subject  to 
the  Excess  Profits  Tax.  This  includes  professional  men,  capitalists, 
salesmen,  and  all  others,  without  regard  to  their  activities  or  employ- 
ment. 

392.— LAW  TAKES  IN  ALL. 

The  language  of  the  law  is  that  "the  terms  'trade'  and  'business' 
include  professions  and  occupations,"  and  that  "every  corporation  or 
partnership  not  exempt  shall  be  deemed  to  be  engaged  in  business, 
and  all  the  trades  and  businesses  in  which  it  is  engaged  shall  be 
treated  as  a  single  trade  or  business." 


238  THE    EXCESS    PROFITS    TAX 

393.— THE  "TAXABLE  YEAR." 

As  the  law  repeatedly  refers  to  the  "taxable  year,"  its  meaning 
must  be  understood. 

In  the  case  of  an  individual,  the  first  "taxable  year,"  under  the 
Excess  Profits  Tax,  is  1917;  and  thereafter  it  is  each  calendar  year 
ending  December  31. 

In  the  case  of  a  corporation  or  partnership,  the  first  "taxable 
year,"  under  this  tax,  is  1917,  and  thereafter  each  calendar  year,  ex- 
cept in  the  case  of  a  corporation  or  partnership  which  has  fixed  its 
own  fiscal  year.  (See  paragrah  on  "Fiscal-year  Return"  in  Income 
Tax  instructions.)  Where  such  fiscal-year  basis  governs,  the  Excess 
Profits  Tax  is  to  be  assessed  the  first  year  only  proportionately  as  the 
fiscal  year  falls  within  the  year  1917.  For  example:  A  corporation 
files  returns  of  income  for  a  fiscal  year  ending  with  the  last  day  of 
August.  In  such  a  case  the  return  would  include  income  for  the 
months  of  September,  October,  November  and  December,  1916.  The 
Excess  Profits  Tax  would  be  computed  for  the  entire  fiscal  year,  but 
only  eight-twelfths  of  the  amount  shown  by  the  computation  would 
be  assessed.  In  subsequent  annual  returns,  however,  the  tax  would 
be  assessed  upon  a  full  twelve-months  basis. 

394.— The  "PRE-WAR  PERIOD." 

The  next  term  of  the  law  to  be  understood  is  "Pre-War  Period." 
This  means  the  years  1911,  1912  and  1913,  if  the  individual,  part- 
nership or  corporation  was  engaged  in  trade,  business  or  profession 
during  the  whole  of  all  three  years.  If  not,  then  as  many  of  such 
years  during  the  whole  of  which  he  or  it  was  thus  engaged.  In  other 
words,  the  "pre-war  period"  is  always  to  be  reckoned  in  whole  years. 
It  may  be  all  three  years,  or  just  1912  and  1913,  or  again  just  1913. 

395.— FOREIGN  CONCERNS  AND 

NON-RESIDENT  ALIEN  INDIVIDUALS. 

Foreign  corporations  and  partnerships  and  non-resident  alien 
individuals  are  subject  to  Excess  Profits  Tax  only  with  respect  to 
net  income  from  sources  within  the  United  States. 

They  are  not  subject  to  this  tax  at  all  if  in  receipt  of  a  net  income 
of  less  than  $3000  from  the  United  States  for  the  taxable  year. 

396.— HOW  TO  DETERMINE  NET  INCOME 
FOR  THIS  TAX 

The  general  basis  of  determining  net  income  for  the  purpose  of 
the  Excess  Profits  Tax  is  that  explained  in  the  chapters  on  Income 


THE    EXCESS    PROFITS    TAX  239 

Tax.  However,  owing  to  the  fact  that  the  Excess  Profits  Tax  com- 
putation extends  back  to  the  year  1911,  the  general  Income  Tax  basis 
must  be  adapted  in  certain  particulars  to  the  Excess  Profits  Tax  for 
three  reasons:  first,  only  the  income  of  corporations  was  subject  to 
tax  prior  to  1913;  second,  even  since  the  income  of  both  corporations 
and  individuals  has  been  subject  to  tax,  beginning  with  the  year 
1913,  there  have  been  changes  in  the  method  of  ascertaining  taxable 
net  income  ;  and,  third,  partnerships  have  never  been  subject  to  income 
tax. 

It  is  therefore  suggested  that  the  brief  instructions  that  follow 
be  carefully  noted: 

397.— FOR  A  CORPORATION. 

A  corporation  can  ascertain  net  income  for  the  Excess  Profits 
Tax  computation  as  follows : 

Net  Income  For  1911 

To  net  income  shown  by  the  return  made  for  the  year  1911  under 
the  Corporation  Excise  Tax  law  of  August  5,  1909,  add  the  deduction 
claimed  in  that  return  for  the  Corporation  Excise  Tax  which  was  paid 
in  1911  but  which  was  assessed  on  the  Corporation  Excise  Tax  re- 
turn filed  for  the  previous  year,  1910.  (Note — By  "net  income" 
shown  by  a  Corporation  Excise  Tax  return  is  meant  the  amount  of 
net  income  prior  to  deduction  therefrom  of  the  exemption  of  $5,000 
allowed  a  corporation  under  that  law.) 

Net  Income  For  1912 

To  net  income  shown  by  the  return  made  for  the  year  1912  under 
the  Corporation  Excise  Tax  law  of  August  5,  1909,  add  the  deduction 
claimed  in  that  return  for  the  Corporation  Excise  Tax  which  was  paid 
in  1912  but  which  was  assessed  on  the  Corporation  Excise  Tax  return 
filed  for  the  previous  year,  1911.  The  "note"  in  preceding  paragraph 
is  also  applicable. 

Net  Income  For  1913 

To  net  income  shown  by  the  return  made  for  the  year  1913  under 
the  Income  Tax  law  of  October  3,  1913,  add  the  deduction  claimed  in 
that  return  for  the  Corporation  Excise  Tax  which  was  paid  in  1913  but 
which  was  assessed  on  the  Corporation  Excise  Tax  return  filed  for 
the  previous  year,  1912.  Then  subtract  that  part  of  the  income  for 
the  year  1913  which  was  derived  from  dividends  paid  by  another  cor- 
poration subject  to  income  tax. 


240  THE    EXCESS    PROFITS    TAX 

Net  Income  For  1917 

From  net  income  shown  by  the  return  made  for  the  year  1917 
under  the  Income  Tax  law  subtract  that  part  of  the  income  for  the 
year  which  was  derived  from  dividends  paid  by  another  corporation 
subject  to  tax.  Should  the  law  not  be  amended  this  instruction  should 
also  be  followed  with  respect  to  years  subsequent  to  1917. 

398.— FOR  AN  INDIVIDUAL. 

An  individual  can  ascertain  net  income  for  the  Excess  Profits  Tax 
computation  by  seeing  that,  for  the  special  purposes  of  this  tax,  the 
method  prescribed  by  the  Income  Tax  law  of  September  8,  1916,  as 
amended  by  the  Act  of  October  3,  1917,  is  conformed  to,  and  by  then 
subtracting  from  the  amount  of  net  income  for  each  year  the  amount 
of  that  year's  income  derived  from  dividends  paid  by  a  corporation 
subject  to  income  tax.  "Net  income,"  for  income  tax  purposes,  in- 
cludes dividends,  a  credit  for  dividends  being  allowed  only  in  the  com- 
putation of  the  normal  tax.  "Net  income,"  for  Excess  Profits  Tax 
purposes,  does  not  include  dividends. 

There  are  a  good  many  difficulties  for  individuals  in  this  require- 
ment of  the  law. 

First — Individuals  did  not  make  income  tax  returns  for  the  years 
1911  and  1912.  Therefore,  they  must  go  back  and  apply  to  their  in- 
come of  those  years  the  requirements  of  the  Act  of  September  8, 
1916  (as  explained  in  the  chapters  on  Income  Tax). 

Second — The  returns  they  made  for  the  year  1913  under  the  first 
Income  Tax  law  of  October  3,  1913,  must  be  revised  to  meet  the  re- 
quirements of  the  Act  of  September  8,  1916. 

The  individual  would  therefore  ascertain  net  income  for  the  pur- 
poses of  the  Excess  Profits  Tax  as  follows : 

FOR  1917 — Deduct  from  net  income  shown  by  the  Income  Tax 
return  the  amount  of  the  year's  income  derived  from  dividends  paid 
by  a  corporation  subject  to  income  tax. 

FOR  1913 — Ascertain  net  income  exactly  as  required  for  1917. 
This  means  that  net  income  for  the  entire  year  1913  must  be  ascer- 
tained, whereas  the  Income  Tax  return  filed  for  1913  included  only 
income  for  the  ten-months'  period  of  the  year  beginning  March  1  and 
ending  December  31,  with  deductions  allowed  on  a  five-sixths  basis. 
It  means  also  that  deductions  should  be  claimed  as  prescribed  for  the 
year  1917  (explained  in  Income  Tax  instructions),  and  not  as  pre- 
scribed for  the  vear  1913.  When  net  income  for  the  vear  1913  has 


THE    EXCESS    PROFITS    TAX  241 

been  thus  ascertained,  deduct  the  amount  of  that  year's  income  de- 
rived from  dividends  paid  by  a  corporation  subject  to  income  tax. 

FOR  1912  AND  1911— No  return  having  been  filed  net  income 
for  each  year  should  be  ascertained  exactly  as  required  for  1917. 

[Note :  In  1913  interest  paid  by  an  individual  on  a  loan  obtained 
to  buy  bonds,  the  interest  on  which  is  exempt  from  income  tax,  was 
allowed  as  a  deduction ;  in  1917  such  outgoing  interest  is  not  allowed 
as  a  deduction.  In  1913  no  deduction  was  allowed  for  contributions 
to  charitable,  religious  or  educational  organizations,  whereas  in  1917 
deduction  is  allowed  within  a  certain  limit  (explained  under  appro- 
priate heading  in  Income  Tax  instructions).  Cognizance  may  be 
taken  of  these  changes  in  the  revision  of  1913  net  income  to  meet  re- 
quirements effective  in  1917.] 

399.— FOR  A  PARTNERSHIP. 

A  partnership,  not  having  filed  a  return  of  income  for  the  pur- 
poses of  the  Income  Tax,  would  ascertain  net  income  for  each  of  the 
years  1911,  1912,  1913  and  1917  exactly  as  an  individual,  being  allowed 
the  same  deductions  and  being  called  upon  to  apply  to  each  of  the 
years  the  requirements  effective  in  1917.  A  partnership  would  also 
subtract  from  the  amount  of  net  income,  ascertained  according  to  In- 
come Tax  regulations,  the  amount  of  the  year's  income  derived  from 
dividends.  A  foreign  partnership  would  proceed  under  the  rules  ap- 
plicable to  a  non-resident  alien  individual. 

400.— GET  COPIES  OF  OLD  RETURNS. 

The  extension  of  the  Excess  Profits  Tax  computation  back  to  the 
year  1911  makes  it  very  important  that — 

Every  corporation  at  once  obtain  copies  of  its  Income  Tax  return 
for  1913  and  its  Corporation  Excise  Tax  returns  for  1911  and  1912,  if 
it  has  not  such  copies  in  its  files  ; 

Also  that  every  individual  at  once  obtain  a  copy  of  his  Income 
Tax  return  for  1913,  if  he  has  not  such  copy  in  his  possession. 

These  copies  of  returns  can  not  be  obtained  from  the  local  Col- 
lector of  Internal  Revenue  for  the  reason  that  returns  of  income  are 
not  kept  in  his  office  and  his  records  do  not  contain  the  essential  data. 
Certified  copies  can,  however,  be  obtained  from  the  office  of  the  Com- 
missioner of  Internal  Revenue  at  Washington,  D.  C.,  and  written  re- 
quest should  be  made  for  them  at  the  earliest  possible  date.  But  a 
copy  of  a  return  will  be  sent  by  the  Commissioner  only  to  the  cor- 
poration or  individual  that  filed  the  return,  or  to  an  attorney  repre- 


242  THE    EXCESS    PROFITS    TAX 

senting  such  corporation  or  individual  when  the  attorney's  request  is 
accompanied  by  evidence  of  his  authority  to  ask  for  and  receive  the 
copy. 

4il.— "INVESTED  CAPITAL." 

Having  ascertained  "net  income,"  as  "net  income"  for  the  pur- 
pose of  the  Excess  Profits  Tax  is  understood  and  has  been  explained 
to  distinguish  it  from  the  "net  income"  upon  which  Income  Tax  is 
assessed,  the  individual,  partnership  or  corporation  should  next  look 
into  the  meaning  of  "Invested  Capital,"  as  defined  for  the  Excess 
Profits  Tax. 

Invested  capital  does  not  here  mean  the  value  of  capital  employed 
in  a  business.  It  means  the  capital  invested  without  regard  to 
the  value  of  the  property,  except  when  property,  tangible  or  in- 
tangible, is  paid  into  the  business  instead  of  cash. 

Invested  capital  can  not  include,  for  the  purpose  of  the  tax  com- 
putation, any  amount  of  investment  represented  by  those  stocks, 
bonds,  or  other  assets,  the  income  from  which  it  not  subject  to  the 
Excess  Profits  tax.  Neither  can  it  include  any  money  or  other  prop- 
erty borrowed.  Referring,  however,  to  the  exclusion  of  bonds,  there 
is  an  exception  in  the  law  in  favor  of  bonds  or  other  obligations  ot 
the  United  States.  Such  bonds,  if  held  by  the  taxpayer,  may  be 
counted  as  a  part  of  invested  capital. 

The  qualifying  clause  with  respect  to  the  exclusion  of  stocks  and 
bonds  from  invested  capital,  is  that  reading — "the  income  from  which 
is  not  subject  to  the  tax  imposed  by  this  title."  By  "this  title"  is 
meant  Title  II,  the  Excess  Profits  Tax  part  of  the  general  War  Rev- 
enue Act  of  October  3,  1917. 

What,  in  general,  are  the  stocks  and  bonds,  the  income  from 
which  is  not  subject  to  Excess  Profits  Tax? 

In  the  first  place,  the  dividends  received  from  a  corporation  sub- 
ject to  income  tax  are  not  subject  to  Excess  Profits  Tax.  Therefore, 
the  stock  on  which  the  dividends  are  paid  can  not  be  counted  as  a  part 
of  invested  capital.  This  exclusion  affects  the  stock  of  all  domestic 
corporations  and  the  stock  of  foreign  corporations,  in  so  far  as  the 
foreign  corporations  are  subject  to  the  American  income  tax. 

On  the  other  hand,  however,  a  foreign  corporation  without  in- 
come from  the  United  States  is  not  subject  to  the  American  income 
tax.  Its  dividends,  therefore,  when  paid  to  a  domestic  corporation  or 
partnership  or  to  a  citizen  or  resident  of  the  United  States,  are  sub- 
ject to  tax,  without  the  offset  of  a  credit.  And  so  it  follows  that  stock 


THE    EXCESS     PROFITS    TAX  243 

in  such  a  foreign  corporation — not  being  stock  the  income  from  which 
is  not  subject  to  Excess  Profits  tax — is  not  excluded  from  invested 
capital. 

As  to  the  bonds  that  are  excluded,  the  bars  seem  to  be  up  against 
all  of  the  public  bonds  except  bonds  of  the  United  States.  Invest- 
ments in  State,  county,  municipal,  school,  irrigation  and  similar  se- 
curities, can  not  be  counted  as  a  part  of  invested  capital,  because  the 
income  from  all  such  bonds  is  exempt  from  tax. 

But  corporation  bonds  are  not  excluded.  And  it  makes  no  differ- 
ence whether  the  corporation  bonds  are  the  so-called  "tax-free"  bonds 
or  not.  The  interest  upon  all  corporation  bonds  is  subject  to  tax; 
therefore,  such  bonds  can  be  counted  as  a  part  of  invested  capital. 

The  invested  capital  of  a  corporation  or  partnership  does  include  : 

(a)  Actual  cash  paid  in, 

(b)  Actual  cash  value,  at  time  of  payment,  of  tangible  property 
received  in  payment  for  stock  or  shares  in  the  corporation 
or  partnership,  except  that  when  such  property  was  received 
in  payment  for  stock  or  shares  prior  to  January  1,  1914,  the 
actual  cash  value  to  be  considered  is  that  of  January  1,  1914. 
In  no  case,  however,  can  tangible  property  thus  received  be 
considered  as  having  an  actual  value  in  excess  of  the  par 
value  of  th  eoriginal  stock  or  shares  issued  for  it. 

(c)  Paid  in  or  earned  surplus  or  undivided  profits  employed  in 
the  business  except  undivided  profits  earned  during  the  tax- 
able year — that  is,  during  the  year  for  which  the  tax  is  com- 
puted. 

(d)  Actual  cash  value,  at  time  of  payment,  of  patents  and  copy- 
rights received  in  payment  for  stocks  or  shares — such  actual 
cash  value  never  to  be  in  excess  of  the  par  value  of  the  stock 
or  shares  issued  for  the  patents  or  copyrights  at  the  time  of 
payment. 

(e)  Good  will,  trade  marks,  trade  brands,  the  franchise  of  a  cor- 
poration   or    partnership,    or    other    intangible    property,    if 
specifically  paid  for  either  in  cash  or  tangible  property — to 
be  considered  invested  capital  only  to  the  amount  of  cash  or 
the  actual  cash  value,  at  time  of  payment,  of  the  tangible 
property  used  in  payment  for  such  intangible  property.  How- 
ever, with  respect  to  the  inclusion  of  such  intangible  property 
in  invested  capital  there  is  imposed  the  condition  that,  when 
purchased  prior  to  March  3,  1917,  with  shares  in  the  corpora- 
tion or  partnership,  issued  prior  to  the  same  date,  the  value 


244  THE    EXCESS    PROFITS    TAX 

of  the  property  can  be  included  in  invested  capital,  not  in  ex- 
cess of  the  actual  cash  value  of  the  property  at  the  time  of 
purchase  or  of  the  par  value  of  the  shares  issued  in  payment 
for  it  at  the  time  of  issue,  provided  that  not  more  than  a  20 
per  cent  interest  in  the  corporation  or  partnership  was  issued 
in  payment  for  the  property. 

The  invested  capital  of  an  individual  includes  : 

(a)  Actual  cash  paid  into  the  trade  or  business. 

(b)  Actual  cash  value  of  tangible  property  paid  into  a  business 
at  the  time  of  such  payment,  except  that  the  inclusion  shall 
be  at  the  value  on  January  1,  1914,  in  the  case  of  property 
paid  into  the  business  prior  to  that  date. 

(c)  Actual  cash  value  of  patents,   copyrights,   good  will,   trade 
marks,  trade  brands,  franchises,  or  other  intangible  property, 
if  paid  for  specifically  in  cash  or  tangible  property.    The  value 
at  which  this  intangible  property  can  be  included  in  invested 
capital  can  never  exceed  the  actual  cash  paid  for  it,  or,  in 
case  payment  is  made  in  tangible  property,  the  actual  cash 
value  at  the  time  of  payment  of  such  tangible  property. 

The  invested  capital  of  a  foreign  corporation  or  partnership,  or  of 
a  non-resident  alien  individual,  is  that  proportion  of  entire  invested 
capital,  as  defined  by  the  lawr,  which  the  net  income  from  sources 
within  the  United  States  bears  to  the  entire  net  income  from  all 
sources. 

402.— ON  REORGANIZATION. 

The  law  provides  that  a  trade  or  business  carried  on  by  a  cor- 
poration, partnership  or  individual  does  not  lose  its  business  identity 
with  the  pre:war  period  even  though  reorganized  on  or  after  January 
2,  1913.  Were  such  business  to  be  considered  as  another  business  en- 
tirely, it  would  not  have  been  engaged  in  business  during  the  whole 
of  even  one  of  the  three  years  of  the  pre-war  period  (not  even  the 
whole  of  the  year  1913).  The  law  provides  that  if  the  trade  or  busi- 
ness after  reorganization  is  substantially  a  continuation  of  a  trade  or 
business  carried  on  prior  to  reorganization,  the  net  income  and  in- 
vested capital  of  the  trade  or  business  prior  to  reorganization  (that  is, 
of  the  predecessor  of  the  reorganized  business)  shall  be  considered  as 
the  net  income  and  invested  capital  of  the  reorganized  business. 

There  is  also  a  provision  in  the  law  relative  to  determination  of 
the  invested  capital  of  a  trade  or  business  in  which  a  reorganiaztion, 
consolidation  or  change  of  ownership  takes  place  subsequent  to  March 


THE    EXCESS    PROFITS    TAX  245 

3,  1917,  (date  of  first  act  imposing  a  war  tax  upon  excess  profits.)  This 
provision  is  to  the  effect  that  when  in  the  reorganization  one-half  or 
more  of  the  interest  or  control  remains  in  the  hands  of  the  same  per- 
sons, the  property  paid  into  the  reorganized  business  can  not  be  in- 
cluded in  the  invested  capital  of  the  reorganized  business  at  a  value 
greater  than  would  have  been  allowed  in  computing  the  invested 
capital  of  the  absorbed  business  had  such  reorganization  not  taken 
place. 

To  illustrate: 

The  New  York  Shoe  Manufacturing  Company  had  been  engaged 
in  business  for  a  number  of  years  when  on  January  2,  1913,  the  busi- 
ness was  reorganized.  All  the  assets  of  the  company  and  its  business 
were  transferred  to  another  corporation  known  as  the  Eastern  Shoe 
Manufacturing  Company.  The  business  of  this  latter  company  was 
substantially  a  continuation  of  the  business  of  the  former  company. 
Were  the  latter  company  to  be  considered  alone,  it  would  be  found 
not  to  have  been  engaged  in  business  for  a  whole  year  of  the  pre- 
war period  comprising  the  years  1911,  1912  and  1913.  But  the  law 
provides  that,  in  such  circumstances,  the  net  income  and  invested  capi- 
tal of  the  New  York  Shoe  Manufacturing  Company  for  the  pre-war 
period  shall  be  taken  as  the  net  income  and  invested  capital  of  the 
Eastern  Shoe  Manufacturing  Company  for  the  pre-war  period,  for  the 
purposes  of  the  Excess  Profits  Tax  computation. 

To  illustrate  again: 

The  partnership  of  Baker  &  Co.,  engaged  in  the  hardware  busi- 
ness, decided  to  take  in  new  capital  and  extend  its  activities.  On 
September  1,  1917  (the  significance  of  this  date  being  that  it  was  sub- 
sequent to  March  3,  1917)  the  partnership  was  reorganized,  or  rather 
absorbed,  and  the  business  was  continued  under  a  new  partnership  of 
Baker,  Button  &  Co.  At  the  time  the  decision  was  reached  to  re- 
organize and  extend  Baker  &  Co.  had  an  invested  capital  of  $90,000. 
The  firm's  business  had  been  so  successful,  however,  that  it  was 
worth  $150,000,  at  which  figure  it  was  turned  into  the  partnership  of 
Raker,  Button  &  Co.  for  a  one-half  interest  in  the  new  firm  to  be 
distributed  to  the  members  of  the  absorbed  firm  of  Baker  &  Co. 
This  value  of  $150,000  was  matched  by  two  new  partners  putting  in 
$75,000  cash  each.  The  invested  capital  of  Baker,  Buton  &  Co.  for 
the  last  four  months  of  1917  did  not,  however,  become  $300,000,  the 
value  of  the  business.  Under  the  Excess  Profits  Tax  law  it  became 
$240,000  ($150,000  in  cash  from  the  new  partners  and  the  assets  re- 


246  THE    EXCESS    PROFITS    TAX 

ceived  from  Baker  &  Co.,  considered  at  the  value  of  $90,000,  for  the 
purposes  of  the  Excess  Profits  Tax, — the  value  that  would  have  been 
allowed  in  computing  the  invested  capital  of  Baker  &  Co.  had  the  re- 
organization not  taken  place). 

403.— AVERAGE  CAPITAL. 

The  law  also  states  that  invested  capital  for  any  year  means  the 
average  invested  capital  for  that  year,  to  be  averaged  monthly. 

To  Illustrate:  Taking  the  second  example  in  the  preceding  para- 
graph, if  the  absorbed  firm  of  Baker  &  Co.  was  in  business  in  the  pre- 
war period  with  the  same  capital  of  $90,000,  which  it  had  prior  to  re- 
organization of  the  business  on  September  1,  1917,  the  "invested  capi- 
tal" of  Baker,  Button  &  Co.,  for  the  pre-war  period,  would,  in  the 
computation  for  the  Excess  Profits  Tax,  be  considered  as  $90,000.  But 
the  "invested  capital"  of  Baker,  Button  &  Co.  for  the  taxable  year 
1917,  would  have  to  be  averaged  monthly,  there  having  been  a  change 
during  the  year. 

For  the  first  eight  months  of  the  year  1917,  the  "invested  capital" 
of  Baker,  Button  &  Co.  would  be  $90,000,  and  for  the  last  four 
months  $240,000.  The  average  for  the  year  1917  would  therefore  be 
$140,000. 

404.— NET  INCOME  AND  INVESTED 
CAPITAL  FOR  TWO  PERIODS. 

The  individual,  partnership  or  corporation  must  thus  ascertain 
both  net  income  and  invested  capital  for  two  distinct  periods  in  order 
to  make  the  Excess  Profits  Tax  computation — first,  for  the  pre-war 
period;  and,  second,  for  the  taxable  year,  the  year  for  which  the 
Excess  Profits  Tax  computation  is  to  be  made.  Having  ascertained 
net  income  and  invested  capital  for  each  of  the  three  years  of  the  pre- 
war period,  the  average  for  those  years  would  be  determined  and  such 
average  would  be  considered  in  fixing  the  varying  part  of  the  deduc- 
tion allowed  from  net  income  of  the  taxable  year  in  the  assessment  of 
the  Excess  Profits  Tax. 

405.— DEDUCTION  ALLOWED. 

The  deduction  allowed  is  of  two  parts :  one  varying,  the  other  an 
amount  fixed  by  the  statute. 

An  individual,  who  is  a  citizen  or  resident  of  the  United  States, 
is  allowed  the  sum  of  (1)  an  amount  equal  to  the  same  percentage 
of  the  invested  capital  for  the  taxable  year  (1917  and  subsequent 


THE    EXCESS     PROFITS    TAX  247 

years)  which  the  average  amount  of  the  annual  net  income  of  the 
trade  or  business  during  the  pre-war  period  (1911,  1912  and  1913)  was 
of  the  invested  capital  for  the  pre-war  period,  and  (2)  the  fixed 
amount  of  $6,000.  The  individual  is,  however,  entitled  to  a  minimum 
allowance  of  7  per  cent  of  invested  capital  for  the  taxable  year  and 
is  limited  to  an  allowance  of  9  per  cent,  and  should  the  percentage  of 
the  pre-war  period  be,  on  the  one  hand,  less  than  7  per  cent  or,  on 
the  other,  more  than  9  per  cent,  it  would  be  disregarded  in  favor  of 
the  statutory  minimum  or  maximum  percentage. 

A  domestic  partnership  is  allowed  exactly  the  same  deduction  as 
an  individual  who  is  a  citizen  or  resident  of  the  United  States. 

A  domestic  corporation  is  allowed  the  sum  of  (1)  an  amount 
equal  to  the  same  percentage  of  the  invested  capital  of  the  taxable 
year  which  the  average  amount  of  the  annual  net  income  of  the  trade 
or  business  during  the  pre-war  period  was  of  the  invested  capital  of 
the  pre-war  period,  and  (2)  the  fixed  amount  of  $3,000.  A  domestic 
Corporation  is,  however,  entitled  to  the  same  minimum  percentage  and 
is  limited  by  the  same  maximum  percentage  of  invested  capital  for 
the  taxable  year,  as  in  the  case  of  an  individual. 

An  individual,  who  is  a  non-resident  alien,  is  allowed  the  same 
deduction  allowed  a  citizen  or  resident  with  the  exception  of  the  fixed 
amount  of  $6,000. 

A  foreign  partnership  is  allowed  the  same  deduction  allowed  a 
non-resident  alien  individual 

A  foreign  corporation  is  allowed  the  same  deduction  allowed  a 
domestic  corporation  with  the  exception  of  the  fixed  amount  of  $3,000. 

406.— NOT  IN  TRADE  OR  BUSINESS 
DURING  PRE-WAR  PERIOD. 

The  deduction,  just  explained,  is  that  intended  to  be  generally 
applicable.  It  will  not  apply,  however,  in  all  cases  and  so  special  pro- 
vision has  been  made  to  the  effect  that  if  a  corporation  or  partnership 
was  not  in  existence,  or  an  individual  was  not  engaged  in  trade  or 
business  during  the  whole  of  at  least  one  of  the  three  years  of  the 
pre-war  period,  the  deduction  shall  be  an  allowance  of  a  flat  8  per  of 
the  invested  capital  for  the  taxable  year  plus  $3,000  for  a  domestic 
corporation,  and  $6,000  for  a  domestic  partnership  or  for  an  individual 
who  is  a  citizen  or  resident  of  the  United  States. 

407.— RATES  OF  TAX. 

The  deduction  should  be  borne  in  mind  in  connection  with  the 
scheme  of  assessment.  The  law  states  that  the  tax  shall  be  at  the 


248  THE    EXCESS    PROFITS    TAX 

following  percentages  of  net  income  for  the  taxable  year  (1917  and 
subsequent  years)  : 

20  per  cent  of  the  amount  of  the  net  income  in  excess  of  the 
deduction  and  not  in  excess  of  15  per  cent  of  the  invested  capital 
for  the  taxable  year. 

25  per  cent  of  the  amount  of  the  net  income  in  excess  of  15 
per  cent  and  not  in  excess  of  20  per  cent  of  such  capital. 

35  per  cent  of  the  amount  of  the  net  income  in  excess  of  20 
per  cent  and  not  in  excess  of  25  per  cent  of  such  capital. 

45  per  cent  of  the  amount  of  the  net  income  in  excess  of  25 
per  cent  and  not  in  excess  of  33  per  cent  of  such  capital. 

60  per  cent  of  the  amount  of  the  net  income  in  excess  of  33 
per  cent  of  such  capital. 

408.— DEDUCTION   ONLY   FOR   FIRST  RATE. 

The  deduction  provided  for  Excess  Profits  Tax  purposes  is  allow- 
able only  for  the  tax  at  the  rate  of  20  per  cent ;  that  is,  the  deduction 
is  to  be  taken  into  the  computation  only  in  the  first  step  of  the  gradu- 
ated tax  scale. 

409.— TAX  WHEN  THERE   IS 
NO  INVESTED  CAPITAL. 

The  above  tax  schedule  is  effective  where  the  allowable  deduction 
can  be  based  either  upon  the  application  of  the  pre-war  relation  be- 
tween net  income  and  invested  capital  to  invested  capital  for  the  tax- 
able year  or  upon  the  flat  allowance  of  8  per  cent  of  invested  capital 
for  the  taxable  year.  But  when  neither  of  those  bases  of  deduction 
can  be  found  it  is  not  effective.  Consequently,  the  law  provides  that 
when  a  trade  or  business  has  no  invested  capital,  or  has  a  mere 
nominal  capital,  instead  of  assessment  according  to  the  graduated 
scale,  there  shall  be  paid  a  tax  of  8  per  cent  upon  net  income  in  ex- 
cess of  a  deduction  of  $6,000  allowed  individuals,  who  are  citizens  or 
residents  of  the  United  States,  $6,000  allowed  domestic  partnerships. 
$3,000  allowred  domestic  corporations,  and  upon  the  net  income  of 
non-resident  alien  individuals  and  foreign  partnerships  and  corpora- 
tions without  deduction. 

410.— TAXPAYER  CAN  COMPLAIN 
AND  ASK  REVISION. 

And  still  other  special  provisions  cover  the  case  of  the  business 
of  the  domestic  corporation  or  partnership,  or  individual  citizen  or 


THE    EXCESS    PROFITS    TAX  249 

resident,  when 

(1)  There  was  no  net  income  during  the  pre-war  period,  or 

(2)  The  return  on  capital  was  low  as  compared  with  the  return 
of  others  in  a  similar  line  of  business,  or 

(3)  The  Government  is  unable  to  determine  to  its  satisfaction 
what  was  the  net  income  for  the  pre-war  period. 

In  any  of  such  circumstances,  the  Treasury  Department  can  de- 
termine the  allowable  deduction  according  to  the  return  on  capital 
in  similar  lines  of  business  during  the  pre-war  period,  adding  to  such 
return  the  fixed  amount  of  $6,000  for  an  individual  or  partnership  or 
$3.000  for  a  corporation. 

Any  taxpayer,  not  satisfied  with  a  deduction  based  upon  the  re- 
turn on  capital  for  the  pre-war  period,  as  determined  by  the  net  in- 
come during  that  period  from  his  own  business,  may  file  protest  with 
the  Department  and  ask  that  his  assessment  (or  the  assessment  of 
the  partnership  or  corporation)  be  made  with  deduction  based  upon 
the  larger  returns  of  similar  kinds  of  business  during  the  pre-war 
period.  In  order  to  claim  this  larger  measure  of  deduction  (and  there- 
fore a  decrease  in  tax)  he  would  have  to  file  return  with  the  deduction 
computed  according  to  his  own  pre-war  income.  He  would  not,  how- 
ever, be  required  to  pay  all  of  the  tax.  Against  that  part  of  the  tax 
considered  by  him  to  be  in  excess  of  the  tax  computed  according  to 
the  pre-war  return  of  similar  kinds  of  business,  he  could  file  a  claim 
on  what  is  known  as  Claim  Form  47.  The  filing  of  this  claim 
would  hold  collection  of  the  excess  in  abeyance  pending  the  Depart- 
ment's action  upon  his  request  for  revision  of  assessment.  Such  claim 
would  have  to  be  filed  at  the  time  of  making  the  return.  It  would  be 
filed  with  the  local  Collector  of  Internal  Revenue  for  transmission  to 
the  Department. 

411.— CAN  APPLY  AVERAGE  DEDUCTION. 

Or,  should  the  Department  be  unable  to  determine  to  its  satisfac- 
tion the  invested  capital  of  any  business,  it  can  grant  to  that  business 
the  average  deduction  allowed  other  representative  businesses  of  the 
same  kind. 

412.— PARTNERSHIPS   MUST   FILE   RETURNS. 

A  return  for  assessment  of  this  tax  is  required  of  every  domestic 
partnership  having  a  net  income  for  the  taxable  year  of  $6,000  or 
more,  and  every  foreign  partnership  having  a  net  income  of  $3,000  or 
more. 


250  THE    EXCESS    PROFITS    TAX 

413.— RETURN  FOR  EXCESS  PROFITS  TAX. 

Liability  to  Excess  Profits  Tax  is  to  be  disclosed  at  the  same 
time  that  liability  to  Income  Tax  is  disclosed.  Unless  prior  to  Janu- 
ary 1,  1918,  the  plans  of  the  Treasury  Department  are  changed,  only 
one  return  will  be  required  for  both  the  Income  Tax  and  the  Excess 
Profits  Tax.  The  individual  or  the  corporation  will  add  to  the  Income 
Tax  return  the  additional  data  essential  to  assessment  of  Excess 
Profits  Tax.  The  partnership  will  have  to  file  a  return,  specially  pre- 
pared for  the  Excess  Profits  Tax,  owing  to  the  fact  that  it  is  not  sub- 
ject to  Income  Tax. 

This  disclosure  of  liability  must  be  made  by  filing  return  not  later 
than  March  1,  1918,  for  the  calendar  year  1917,  and  not  later  than 
March  1,  thereafter,  for  the  preceding  calendar  year.  In  the  case  of 
£,  corporation  or  partnership  filing  according  to  its  own  fiscal  year, 
the  return  must  be  filed  not  later  than  60  days  after  the  close  of  such 
fiscal  year. 

Otherwise,  all  the  requirements  of  the  Income  Tax  law  relative  to 
disclosure  of  liability  and  payment  of  tax,  and  penalties  for  non-com- 
pliance, are  applicable  to  the  Excess  Profits  Tax. 

414.— PHILIPPINES   AND   PORTO   RICO. 

Under  the  Excess  Profits  Tax  law  residence  in  the  Philippine- 
Islands  or  Porto  Rico  is  not  considered  residence  in  the  United  States! 
An  alien,  therefore,  residing  in  the  Philippines  or  Porto  Rico,  is  a 
non-resident  alien.  A  corporation  or  partnership  created  under  the 
laws  of  either  the  Philippines  or  Porto  Rico  is  a  foreign  corporation 
or  partnership.  The  term  "United  States"  means  only  the  States,  the 
Territories  of  Alaska  and  Hawaii  and  the  District  of  (Columbia. 

415.— WHEN   INTEREST  ON   LIBERTY  4'S 
MUST  BE  INCLUDED. 

If  an  individual,  partnership  or  corporation  holds  Liberty  Loan 
bonds  of  the  second  series,  or  any  certificates  of  the  United  States 
issued  subsequent  to  September  1,  1917,  in  sufficient  amount  to  make 
the  aggregate  principal  exceed  $5,000,  then  the  interest  received  upon 
the  amount  of  principal  in  excess  of  $5,000  must  be  taken  into  account 
in  connection  with  the  computation  of  the  Excess  Profits  Tax.  After 
having  ascertained  "net  income,"  for  the  purposes  of  the  Excess 
Profits  Tax,  as  already  explained  in  this  chapter,  the  holder  of  the 
bonds,  or  certificates,  may  add  to  the  amount  of  such  "net  income" 
the  amount  of  interest  received  upon  the  principal  in  excess  of  $5,000. 


THE    EXCESS    PROFITS    TAX  251 

The  result  would  be  "net  income,"  for  the  purposes  of  the  Excess 
Profits  Tax,  in  the  case  of  any  person,  partnership  or  corporation 
holding  bonds  of  an  aggregate  principal  of  more  than  $5,000.  Up  to 
and  including  an  aggregate  principal  of  $5,000,  however,  the  interest 
paid  upon  these  bonds,  or  certificates,  is  exempt  from  Excess  Profits 
Tax. 

416.— ILLUSTRATIVE  CASES. 

A  few  illustrations  of  tax  computation  to  emphasize  salient 
features  of  the  law  have  been  worked  out  in  the  examples  that  follow. 
The  examples  deal,  mainly,  with  corporations.  An  example  can, 
however,  be  adapted  to  the  case  of  a  domestic  partneship  or  an  in- 
dividual who  is  a  citizen  or  resident  of  the  United  States  by  adding 
a  fixed  allowance  of  $6,000,  instead  of  $3,000,  in  determining  the  total 
allowable  deduction. 

A  foreign  corporation  or  partnership,  or  non-resident  alien  in- 
dividual would  not  be  allowed  any  fixed  amount  of  $3,000  or  $6,000  in 
-.letermining  the  deduction. 

Also,  no  adaptation  can  be  made  to  the  case  of  an  individual  when 
a  fiscal-year  basis  of  filing  is  involved.  Only  a  corporation  or  a  part- 
nership can  file  according  to  a  year  ending  with  the  last  day  of  some 
month  other  than  December.  An  individual  must  file  for  the  calendar 
year. 

The  illustrations  follow : 


No.  1 


(Capital  the  same;  slight  increase  in  earnings) 


The  average  invested  capital  of  a  corporation  for  the  pre-war  period 
(1911 — 1912 — 1913)  was  $100,000.  Its  average  net  annual  earnings  for  that 
period  were  $8,000.  Thus  its  percentage  of  return  on  capital  was  8  per  cent. 
Its  invested  capital  in  1917  is  the  same  ($100,000).  Its  net  income  for  the  year 
1917  is  $10.000. 

To  get  deduction: 

Take  8  per  cent  of  invested  capital  of  1917.  Eight  per  cent  of  $100,000  is 
$8,000.  To  this  add  the  fixed  allowance  of  $3,000.  The  total  deduction  is  there- 
fore $11,000. 

This  deduction  is  in  excess  of  net  income  for  1917,  and  so  there  is  no  tax 
at  the  20  per  cent  rate. 

The  net  income  for  1917  is  not  in  excess  of  15  per  cent  of  the  invested 
capital  for  that  year,  and  so  there  is  no  tax  at  the  25  per  cent  rate. 

There  is  no  Excess  Profits  Tax  at  all. 


252  THE    EXCESS    PROFITS    TAX 

No.  2 

(Capital  the  same;   illustrating  restriction  to  the  maximum  of 

9  per  cent) 


The  average  invested  capital  of  a  corporation  for  the  pre-war  period  was 
$100,000.  Its  average  net  income  for  that  period  was  $10,000.  Thus  its  percent- 
age of  return  on  capital  was  10  per  cent.  Its  invested  capital  for  1917  is  the 
same  ($100,000).  Its  net  income  for  1917  is  $25,000. 

To  get  deduction: 

The  full  percentage  of  the  pre-war  period  can  not  be  used.  Nine  per  cent 
is  the  maximum.  Therefore,  take  9  per  cent  of  $100,000.  To  the  amount  of 
$9,000  thus  obtained  add  $3,000,  the  fixed  allowance.  The  result  is  $12,000,  the 
total  allowable  deduction. 

To  compute  tax : 

20  per  cent  of  the  amount  of  net  income  in  excess  of  the  deduction 
($12,000)  and  not  in  excess  of  15  per  cent  of  invested  capital  for  1917 
($15,000)  means  that  $3,000  is  subject  to  the  20  per  cent  rate,  the  tax 
Deing  $  600 

25  per  cent  of  the  amount  of  net  income  in  excess  of  15  per  cent 
($15,000)  and  not  in  excess  of  20  per  cent  ($20,000)  of  invested  capital 
for  1917  means  that  $5,000  is  subject  to  the  25  per  cent  rate,  the 
tax  being 1,250 

35  per  cent  of  the  amount  of  net  income  in  excess  of  20  per  cent 
($20,000)  and  not  in  excess  of  25  per  cent  ($25,000)  of  invested  capital 
for  1917  means  that  $5,000  is  subject  to  the  35  per  cent  rate,  the 
tax  being  ..  1,750 


Total    tax...  ....$3,600 


No.  3 


(Capital  the  same,  but  great  increase  in  earnings;  illustrating  allow- 
ance of  minimum  percentage — also  right  of  appeal) 


The  average  invested  capital  of  a  corporation  for  the  pre-war  period  was 
$1,000,000.  Its  average  net  income  for  that  period  was  only  $60,000  a  year. 
Thus  its  percentage  of  return  on  capital  was  only  6  per  cent.  Its  invested 
capital  for  1917  is  the  same  ($1,000,000).  Its  net  income  for  1917  is  $400,000. 

To  get  deduction : 

The  minimum  percentage  of  7  per  cent  can  here  be  claimed.  Therefore, 
disregard  the  pre-war  percentage  of  6  per  cent,  and  take  7  per  cent  of  $1,000,000. 
To  the  amount  of  $70,000  thus  obtained  add  $3,000,  the  fixed  allowance.  The 
result  is  $73,000,  the  total  allowable  deduction. 

To  compute  tax: 

20  per  cent  of  net  income  in  excess  of  the  deduction  ($73,000)  but 
not  in  excess  of  15  per  cent  of  the  1917  capital  ($150,000)  means  that 
$77,000  is  subject  to  tax  at  the  20  per  cent  rate,  the  tax  being $15,400 


THE    EXCESS    PROFITS    TAX  253 

25  per  cent  of  net  income  in  excess  of  15  per  cent  ($150,000)  and 
not  in  excess  of  20  per  cent  ($200,000)  of  the  1917  capital  means  that 
$50,000  is  subject  to  the  25  per  cent  rate,  the  tax  being 12,500 

35  per  cent  of  net  income  in  excess  of  20  per  cent  ($200,000)  and 
not  in  excess  of  25  per  cent  ($250,000)  of  the  1917  capital  means  that 
$50,000  is  subject  to  the  35  per  cent  rate,  the  tax  being 17,500 

45  per  cent  of  net  income  in  excess  of  25  per  cent  ($250,000)  and 
not  in  excess  of  33  per  cent  ($330,000)  of  the  1917  capital  means  that 
$80,000  is  subject  to  the  45  per  cent  rate,  the  tax  being 36,000 

60  per  cent  of  the  net  income  in  excess  of  33  per  cent  ($330,000)  of 
the  1917  capital  means  that  $70,000  is  subject  to  the  60  per  cent  rate, 
the  tax  being .'....  42,000 


Total    Tax $123,400 


In  a  case  of  this  kind  a  corporation  could,  if  it  chose,  take  advantage  of  the 
right  of  appeal  offered  in  Section  205  of  the  law. 


No.  4 

(Corporation  not  engaged  in  business  in  pre-war  period;  began  busi- 
ness June  1,  1917,  and  desires  to  file  according  to  its  own  fiscal 
year,  ending  with  the  last  day  of  May) 


The  corporation's  capital  has  not  varied  from  its  original  amount  of 
$100,000.  Its  net  income  for  the  fiscal  year  beginning  June  1,  1917  and  ending 
May  31,  1918,  is,  of  course,  not  yet  known. 

To  get  deduction: 

Take  8  per  cent  of  the  invested  capital.  To  the  amount  of  $8,000  thus 
obtained  add  the  fixed  allowance  of  $3,000.  The  result  is  $11,000,  the  total 
allowable  deduction. 

To  compute  tax: 

If  capital  is  not  increased  prior  to  the  end  of  the  fiscal  year,  the  computa- 
tion can  be  made,  as  outlined  in  preceding  examples,  after  net  income  for  the 
fiscal  year  has  been  ascertained. 

If  capital  is  increased,  there  will,  of  course,  be  an  increase  of  the  variable 
part  of  the  allowable  deduction. 

To  fix  fiscal  year: 

Not  later  than  30  days  prior  to  March  1,  1918  give  notice  in  writing  to  local 
Collector  of  Internal  Revenue,  stating  that  return  will  be  filed  for  fiscal  year 
ending  last  day  of  May.  (In  case  of  corporation  same  notice  should  also  be 
given  for  income  tax.) 

It  will  not,  then,  be  necessary  to  file  return  until  after  May  31,  1918.  Re- 
turn must  be  filed  within  60  days  after  May  31,  1918. 


No.  5 
(Increase  of  capital;  also  great  increase  of  earning  percentage) 


The  average  capital  of  a  corporation  for  the  pre-war  period  was  $500,000. 
Its  average  annual  net  income  was  $50,000.  The  pre-war  percentage  of  return 
on  capital  was,  therefore,  10  per  cent.  Capital  had  been  increased  until  it  was 
$1,500,000  at  which  figure  it  has  remained  through  1917.  Net  income  for  1917 

is  $450,000. 


254  THE    EXCESS     PROFITS    TAX 

To  get  deduction: 

The  full  percentage  of  the  pre-war  period  can  not  be  used.  Therefore,  take 
9  per  cent  (the  maximum)  of  $1,500,000.  To  the  amount  of  $135,000  thus  ob- 
tained add  $3,000,  the  fixed  allowance.  The  result  is  $138,000,  the  total  allow- 
able deduction. 

To  compute  tax : 

20  per  cent  of  net  income  in  excess  of  the  deduction  ($138,000)  and 
not  in  excess  of  15  per  cent  of  1917  capital  ($225,000)  means  that 
$87,000  is  subject  to  the  20  per  cent  rate,  the  tax  being $17,400 

25  per  cent  of  net  income  in  excess  of  15  per  cent  (225,000)  and  not 
in  excess  of  20  per  cent  ($300,000)  of  1917  capital  means  that  $75,000 
is  subject  to  the  25  per  cent  rate,  the  tax  being 18,750 

35  per  cent  of  net  income  in  excess  of  20  per  cent  ($300,000)  and 
not  in  excess  of  25  per  cent  ($375,000)  of  1917  capital  means  that 
5575,000  is  subject  to  the  35  per  cent  rate,  the  tax  being 26,250 

45  per  cent  of  net  income  in  excess  of  25  per  cent  ($375,000),  in 
this  case  means  that  $75,000,  the  remainder  of  the  net  income  is  sub- 
ject to  the  45  per  cent  rate,  the  tax  being 33,750 


Total  Tax  ....$96.150 

No.  6 


(Increase  of  capital  during  the  taxable  year;  the  monthly  average) 


On  January  1,  1917,  a  corporation's  capital  was  $100,000;  on  June  1,  1917,  it 
was  increased  to  $200,000,  and  again  on  October  1.  1917.  to  $250.000. 
There  were:   5  months  at  $100,000. 
4  months  at  $200,000. 
3  months  at  $250,000. 

The  average  invested  capital  for  1917,  for  the  purpose  of  the  Excess  Profits 
Tax  computation  would  be  the  average,  or  $170.833.33. 


No.  7 


(Without  invested  capital,  or  when  invested  capital  is  merely  nominal) 


A  professional  man  has  a  net  income  from  the  practice  of  his  profession 
for  1917  of  $30,000. 

The  only  deduction  in  such  a  case  would  be  $6,000. 

The  tax  in  such  a  case  would  be  8  per  cent  of  net  income  ($30,000)  in  excess 
of  the  deduction  ($6,000)  which  means  that  $24.000  would  be  subject  to  the  8 
per  cent  rate,  the  tax  being  $1,920. 


417.— OLD  EXCESS  PROFITS  TAX 

LAW  REPEALED— TAX  IS  CREDITED. 

The  Excess  Profits  Tax  provisions  of  the  Act  of  March  3,  1917, 


THE    EXCESS     PROFITS    TAX  255 

are  repealed  by  the  Excess  Profits  Tax  provisions  of  the  Act  of  Oc- 
tober 3,  1917. 

However,  any  tax  paid  under  the  old  law  will  be  allowed  as  a 
credit  under  the  new  law..  If  the  amount  paid  under  the  old  law  is 
in  excess  of  the  amount  due  under  the  new  law,  a  claim  for  refund 
may  be  filed. 

418.— MUNITIONS   TAX   REPEALED 
AT  END  OF  1917. 

The  Munition  Manufacturers'  Tax,  imposed  by  the  Act  of  Sep- 
tember 8,  1916,  remains  in  effect  during  the  year  1917,  but  no  longer. 
The  War  Revenue  Act  provides  for  its  repeal  at  the  end  of  the  year 
1917  and  at  the  same  time  reduces  the  tax  rate  applicable  to  1917  from 
}2y-2  to  10  per  cent. 

This  tax  is  upon  the  net  profits  derived  during  the  year  by  every 
person,  partnership  or  corporation  manufacturing  and  disposing  of — 

(a)  Gunpowder  and  other  explosives,  except  blasting  powder 
and  dynamite  used  for  industrial  purposes ; 

(b)  Cartridges,  loaded  and  unloaded,  caps  or  primers,  except 
those  used  for  industrial  purposes; 

(c)  projectiles,  shells  or  torpedoes,  shrapnel  and  fuses; 

(d)  firearms  and  appendages,  and  bayonets  ; 

(e)  electric  motor  boats,  submarine  or  submersible  vessels; 

(f)  or  any  part  of  the  articles  mentioned  above  in  sub-para- 
graphs (b),  (c),  (d)  and  (e). 

419.— PAYMENT  OF  TAX. 

The  Excess  Profits  Tax  is  to  be  paid  when  the  Income  Tax  is 
paid.  The  provisions  of  the  Income  Tax  law  with  respect  to  time  of 
assessment  and  time  and  form  of  payment  apply. 


256  THE    CAPITAL    STOCK    TAX 


CHAPTER  XXVII 


CAPITAL  STOCK  TAX 


ON   CORPORATIONS 


420.— AN  EXCISE  TAX. 

The  Capital  Stock  Tax  is  an  excise  tax  upon  the  "doing  of  busi- 
ness" by  a  corporation.  It  is  what  is  known  as  a  "Special  Tax,"  and 
was  first  imposed  by  the  Act  of  September  8,  1916.  It  is  still  in  effect 
and  has  proved  one  of  the  most  troublesome  of  the  Federal  taxes, 
owing  to  the  basis  of  assessment. 

421.— FAIR  VALUE  OF  STOCK  THE  MEASURE. 

The  measure  of  the  tax  is  the  fair  value  of  capital  stock,  with 
surplus  and  undivided  profits  to  be  included  in  ascertaining  such  fair 
value.  The  statute  says  that  "fair  value"  shall  be  the  basis  of  assess- 
ment but  the  Treasury  Department  has  at  various  times  by  regula- 
tion, tried  to  make  the  basis  "fair  market  value."  In  this  it  has  not 
entirely  succeeded  for  the  simple  reason  that  the  impossibility  of  giv- 
ing a  "fair  market  value"  to  the  stock  of  every  corporation  engaged 
in  business  is  so  obvious  that  it  does  not  require  explanation.  Cer- 
tainly by  arbitrary  methods  prescribed  in  general  rules  the  best  that 
can  be  done  in  many  cases  toward  determining  a  "fair  market  value" 
is  a  haphazard  attempt  at  approximation. 

422.— THE  TAX  YEAR. 

The  period  for  which  this  tax  is  paid  is  the  fiscal  year  of  the  Gov- 
ernment— from  July  1  of  one  year  to  June  30  of  the  following  year. 
This  is  the  case  with  all  of  the  Special  taxes. 

423.— WHEN  TO  MAKE   RETURN. 

The  return,  or  disclosure  of  liability,  must  be  filed  during  the 
month  of  July.  (The  next  return  due  after  the  publication  of  this 


THE    CAPITAL    STOCK    TAX  257 

book  is  to  be  filed  in  July,  1918,  for  the  fiscal  year  beginning  July  1. 
1918  and  ending  June  30,  1919.)  If  the  return  is  not  filed  in  July,  a 
penalty  attaches  for  delinquency  equal  to  50  per  cent  of  the  amount  of 
the  tax.  Also  the  corporation  is  liable  to  prosecution  for  doing  busi: 
ness  without  having  paid  the  Special  Excise  tax. 

A  domestic  corporation  should  file  return  on  Form  707 ;  a  foreign 
corporation  on  Form  708. 

424.— TAX  RATE. 

The  tax  is  imposed  at  the  rate  of  50  cents  for  each  full  $1,000 
of  the  fair  value  of  the  corporation's  issued  and  outstanding  capital 
stock.  (Note  the  word  "full,"  above.)  For  example  :  A  corporation's 
return  on  Form  707  shows  a  fair  value  of  capital  stock  of  $675,490,  in 
excess  of  the  exemption.  Its  tax  would  be  $337.50,  computed  on 
$675,000,  the  amount  of  $490  (being  less  than  $1,000)  being  disre- 
garded. 

425.— BASIC  QUALIFICATIONS. 

A  corporation,  to  be  subject  to  this  tax,  must  have  been  organized 
for  profit;  it  must  also  have  a  capital  stock  represented  by  shares. 

426.— BOTH  DOMESTIC  AND  FOREIGN. 

Both  domestic  and  foreign  corporations  are  subject  to  the  tax — 

( a )  A  domestic  corporation,  which  was  engaged  in  business  in  the 
preceding  fiscal  year  (that  is,  the  fiscal  year  ending  June  30,  just  pre- 
ceding the  July  in  which  return  must  be  filed)  and  which  is  continuing 
in  business  in  the  fiscal  year  beginning  in  the  July  when  it  must  file 
return.    (See  illustration  below.) 

(b)  A  foreign  corporation    engaged    in   business    in   the    United 
States,  as  explained  above. 

Illustration,  referring  to  (a),  above:  A  corporation  not  engaged 
in  business  in  the  fiscal  year,  July  1,  1917 — June  30,  1918,  would  not  be 
subject  to  the  tax  even  though  it  should  engage  in  business  during  the 
year  1918  subsequent  to  June  30,  1918.  Again,  a  corporation  engaged 
in  business  during  the  whole  or  a  part  of  the  fiscal  year,  July  1,  1917— - 
June  30,1918,  but  not  continuing  in  business  subsequent  to  June  30, 
1918,  would  not  have  to  file  a  return  in  July,  1918.  The  corporation 
would  have  to  be  engaged  in  business  for  at  least  a  part  of  the  fiscal 
year,  July  1,  1917 — June  30,1918,  and  continue  in  business  subsequent 
to  June  30,  1918  (that  is  in  the  fiscal  year  beginning  July  1,  1918)  to 
be  liable  to  file  a  return  in  July,  1918,  and  pay  tax  for  the  fiscal  year 
beginning  with  that  month. 


; 


258  THE    CAPITAL    STOCK    TAX 

427.— EXEMPTION. 

A  domestic  corporation  is  allowed  an  exemption  of  $99,000.  The 
tax  is  imposed  upon  fair  value  of  capital  stock  only  in  excess  of 
$99,000.  (Note  :  See  paragraph  "Amount  Requiring  Return,"  below.) 

A  foreign  corporation,  if  it  makes  a  return  showing  its  entire 
capital  is  entitled  to  that  proportion  of  $99,000  which  its  capital  in- 
vested in  the  United  States  bears  to  its  entire  invested  capital. 

428.— AMOUNT  REQUIRING  RETURN. 

But  a  return  must  be  filed  by  a  domestic  corporation  if  the  fair 
value  of  the  outstanding  capital  stock  is  $75,000  or  over.  This  is  the 
ruling  of  the  Department.  In  other  words,  the  Department  is  to  bo 
the  judge  as  to  whether  tax  is  due,  with  the  margin  between  $75,000 
and  $99,000  within  which  to  work.  A  great  many  corporations,  under 
this  ruling,  have  to  file  returns  but  do  not  have  to  pay  the  tax. 

429.— WITH  NET  INCOME  OF  $6,000. 

Recently  the  Department  instructed  its  field  officers  to  check  over 
the  Income  Tax  assessment  lists  and  call  upon  every  corporation  with 
an  annual  net  income  of  $6,000  or  more  to  show  cause  why  it  should 
not  have  filed  Capital  Stock  Tax  returns  for  past  fiscal  years,  if  it  did 
not  do  so.  It  is  therefore  suggested  that  every  corporation  whose  net 
income  has  amounted  to  $6,000  or  more  a  year,  look  closely  to  the 
value  of  its  outstanding  capital  stock  and,  if  it  find  that  it  should  have 
filed  Capital  Stock  Tax  returns,  do  so  at  once  before  demand  is  made 
upon  it.  By  voluntary  filing,  accompanied  by  a  showing  that  failure 
to  file  was  due  to  a  misunderstanding  of  the  law,  a  corporation  can 
avoid  the  penalties  that  otherwise  would  be  incurred. 

430.— BELOW  $75,000,  NOT  REQUIRED  TO  FILE. 

If  a  corporation's  outstanding  capital  stock  has  a  fair  value  of  less 
than  $75,000,  it  is  not  required  to  file  a  return.  But  it  should  be  on  the 
safe  side,  and  look  carefully  into  the  question  of  its  liability.  There 
seems  to  be  a  conviction  in  official  quarters  that  this  law  has  not  been 
obeyed,  and  the  penalties  of  the  law  will  be  enforced,  should  the  filing 
of  a  return  have  to  be  forced  by  investigation. 

A  corporation  should  look  closely  into  its  own  case,  as  outlined  in 
this  and  preceding  paragraphs,  and  make  sure  of  its  position. 

431.— RETURN  BY  FOREIGN  CORPORATION. 

A  return  is  required  of  every  foreign  corporation  engaged  in  busi- 
ness in  the  United  States,  regardless  of  the  value  of  its  capital,  or  of 
the  capital  invested  in  the  United  States. 


THE    CAPITAL    STOCK    TAX  259 

432.— CORPORATIONS   EXEMPT. 

All  corporations  exempt  from  payment  of  Income  Tax  are  also 
exempt  from  this  Capital  Stock  Tax.  (See  list  in  chapter  "Corpora- 
tions Exempt.") 

Also  mutual  companies  are  exempt,  since  they  have  not  a  capita! 
stock  represented  by  shares,  as  the  law  requires. 

433.— VALUE  OF  CAPITAL  STOCK. 

The  fair  average  value  of  the  capital  stock  for  the  preceding  year 
is  the  basis  of  assessment.  By  this  is  meant  the  value  for  the  preced- 
ing fiscal  year.  In  the  case  of  a  return  filed  in  July,  1918,  it  would  bfe 
the  fair  average  value  for  the  fiscal  year  ending  June  30,  1918. 

434.— TO  ASCERTAIN   FAIR  VALUE. 

Three  methods  for  ascertaining  the  fair  value  of  capital  stock  for 
the  purposes  of  this  tax  will  be  found  in  the  form  for  the  return  (Form 
707).  One  of  them  should  be  selected.  They  are  quoted  as  follows  : 

When  Stock  Is 
Listed  on  Exchange 

(a)  Case  I. — If  the  stock  is  listed  on  any  exchange  its  fair  value 
will  be  determined  by  adding  the  quoted  highest  bid  price  for  the  stock 
on  the  last  business  day  of  each  month  during  the  preceding  fiscal  year 
(or,  if  no  bid  price  was  quoted  on  the  last  day,  in  the  month  on  which 
a  bid  was  quoted),  and  dividing  by  12,  the  result  being  the  average  bid 
price  per  share  for  that  year. 

Stock  Not  Listed, 
But  Has  Been  Sold 

(b)  Case  II. — If  the  stock  is  not  listed  on  any  exchange,  but  sales 
thereof  have  been  actually  made,  and  the  price  paid  for  the  stock  is 
known  to  the  officer  making  the  return,  or  can  be  discovered  by  him, 
the  average  price  at  which  sales  were  made  during  the  preceding  fiscal 
year  shall  be  the  determining  factor  in  ascertaining  the  fair  value  per 
share. 

(In  the  foregoing  two  cases  the  actual  fair  value  of  the  stock  is 
ascertainable  from  the  facts  without  the  necessity  of  making  an  esti- 
mate.) 

When  Fair  Value 
Must  Be  Estimated 

(c)  Case  III. — If  Case  I  and  Case  II  can  not  be  applied,  viz.,  the 
stock  is  not  listed  on  any  exchange,  and  no  actual  sales  have  been  made 
during  the  preceding  fiscal  year,  or  if  the  price  at  which  sales  have 
been  made  is  not  known  to  the  officer  making  the  return,  the  fair  aver- 
age value  of  the  capital  stock  shall  be  estimated,  and  the  surplus  and 
undivided  profits  for  the  preceding  fiscal  year  will  be  taken  into  con- 
sideration as  required  by  the  statute,  as  well  as  the  nature  of  the  busi- 
ness, its  earning  capacity  and  average  dividends  paid,  or  profits  earned, 
during  the  preceding  five  years. 


260  THE    CAPITAL    STOCK    TAX 

The  fair  value  per  share,  ascertained  or  estimated  according  to 
one  of  the  methods  quoted  above,  multiplied  by  the  number  of  shares 
outstanding  will  give  the  fair  average  value  of  all  outstanding  capital 
stock.  If  this  is  $75,000  or  more,  in  the  case  of  a  domestic  corporation, 
a  return  must  be  filed.  Tax  is  imposed,  however,  only  if  the  amount 
exceeds  $99,000. 

435.— WHEN   EARNING   CAPACITY   GOVERNS. 

When  Case  III,  as  quoted  above,  must  be  used  and  the  fair  aver- 
age value  of  capital  stock  must  be  estimated  by  the  earning  capacity 
during  a  period  of  five  years,  if  the  corporation  has  been  engaged  in 
business  for  that  length  of  time,  the  computation  becomes  practically 
a  capitalization  based  upon  the  percentage  of  return.  The  Treasury 
Department  takes  the  position  that  the  average  percentage  of  profits 
over  the  five-year  period  indicates  earning  capacity  from  which  may 
be  estimated  the  fair  value  of  capital  stock.  For  the  guidance  of  its 
officers  the  Department  has  issued  a  statement  to  the  effect  that  an 
examination  of  the  Income  Tax  returns  of  a  large  number  of  corpora- 
tions of  different  classes,  whose  stock  is  listed,  has  shown  they  earn 
approximately  the  following  rates  in  order  to  make  their  stock  worth 
par : 
Banking : 

(1)  West  of  Mississippi  River 8  per  cent 

(2)  East  »          "  "      6     "     " 

Mercantile    10     "     " 

Mining    10     "     " 

Industrial     10     "     " 

Oil-producing    15     "     " 

Oil-refining    10     "     " 

Public  Utilities: 

Railroads    8     "     " 

Light   and   Power 8     "     " 

Electric    Railway 8     "     " 

436.— SUBSIDIARY   CORPORATIONS. 

The  regulations  of  the  Department  are  that,  where  a  parent  com  - 
pany  owns  the  stock  of  several  subsidiary  companies,  which  is  not 
listed  and  which  has  not  been  sold  in  the  last  fiscal  year,  the  fair  valuo 
of  the  stock  of  the  subsidiary  companies  should  be  ascertained  by  ap- 
portionment of  the  fair  value  of  the  total  capital  stock  of  the  parent 
(or  holding)  company,  among  the  subsidiaries,  according  to  the  earn- 
ings derived  from  each  subsidiary  during  the  preceding  year. 


THE    CAPITAL    STOCK   TAX  261 

This  would  not,  however,  relieve  the  parent  (or  holding)  com- 
pany of  liability.  Both  the  parent  company  and  the  subsidiaries 
would  have  to  make  return  and  pay  the  tax,  if  within  the  other  re- 
quirements of  the  law. 

437.— SPECIAL  RULINGS. 

Alany  cases  that  arose  under  this  law  during  the  latter  part  of 
1916  and  early  part  of  1917  required  special  attention.  Correspond- 
ence brought  out  the  following  special  rulings  : 


A  domestic  corporation  is  not  allowed  deduction  for  any  amount 
of  capital  invested  in  a  foreign  country. 


Any  surplus  or  undivided  profits  of  a  corporation  invested  in 
bonds  or  other  securities  having  no  connection  with  the  business  of 
the  corporation  will  be  taken  into  consideration  if  the  method  out- 
lined in  Case  Hi,  explained  above,  is  used.  Any  such  investment 
should,  however,  be  stated  in  the  return,  and  special  attention  should 
be  called  to  it. 


Capital  stock  that  has  once  been  issued  by  a  corporation  is  re- 
garded as  "outstanding,"  even  though  it  is  afterwards  acquired  by  the 
corporation  and  carried  as  "treasury  stock." 


The  surplus  and  undivided  profits,  if  any,  when  stated  in  a  return, 
should  be  those  shown  by  the  books  for  the  preceding  fiscal  year  end 
ing  June  30.    If,  however,  a  corporation  prefers,  it  may  use  the  figures 
shown    by    the    books    for    the    last    preceding  calendar  year  ending 
December  31. 


I  f  the  average  profits  per  share  during  the  preceding  five  years 
indicate  an  earning  capacity  in  excess  of  book  value,  the  fair  value  of 
the  capital  stock  may  be  based  upon  a  reasonable  return  on  capital 
invested,  the  hazards  of  the  business  or  the  market  price  of  stock  of 
similar  corporations  being  taken  into  consideration. 

If  the  book  value  results  from  an  over-estimation  of  capital 
assets,  the  fact  should  be  set  forth  in  a  statement  attached  to  the  re- 
turn, so  that  it  may  be  considered  in  the  assessment. 

A  corporation,  in  business  during  any  part  of  the  preceding  fiscal 
year  but  not  in  business  in  July,  1918,  is  not  required  to  file  return  in 


262  THE    CAPITAL    STOCK    TAX 

July  and  pay  tax  for  the  ensuing  fiscal  year.  But  should  it  resume 
business  at  any  time  during  the  fiscal  year,,  beginnig  July  1,  1918,  it 
would  have  to  file  return  in  the  month  in  which  it  resumes  business, 
and  pay  tax  computed  according  to  the  remainder  of  the  fiscal  year, 
counting  in  full  the  month  in  which  business  is  resumed. 


A  corporation  in  the  hands  of  a  receiver  at  the  opening  of  the 
fiscal  year  is  not  required  to  file  return.  The  same  relief  from  liability 
applies  to  a  corporation  in  the  hands  of  a  receiver  during  all  of  the 
preceding  fiscal  year. 

If  the  combined  stocks  of  two  banks  (in  this  case,  a  bank  and  a 
trust  company)  have  a  definite  market  value,  but  each  stock  has  not 
a  separate  market  value,  the  combined  market  value  may  be  appor- 
tioned between  the  two  corporations  on  the  basis  of  the  capital  stock, 
surplus  and  undivided  profits  of  each. 

Corporations  that  have  no  regular  earnings,  such  as  those  organ- 
ized to  develop  and  sell  timber  lands,  mining  properties,  and  other 
real  property,  and  corporations  that  have  had  no  profits  during  the 
past  five  years,  can  not  base  value  of  capital  stock  upon  earning  capa 
city.  They  are  allowed  to  substitute  an  estimate  based  upon  book 
value  but  should  attach  to  their  returns  an  explanatory  statement. 

438.— WHAT  DOES   "ENGAGED   IN   BUSINESS"  MEAN? 

A  corporation  is  not  liable  to  the  Capital  Stock  Tax  unless  it  is 
"engaged  in  business,"  within  the  meaning  of  the  term  according  to 
the  law. 

The  question  therefore  becomes  one  of  great  importance.  When 
is  a  corporation  "engaged  in  business?" 

The  Treasury  Department  has  not  given  a  definite  answer.  It 
has  ruled  in  individual  cases,  but  has  not  laid  down  a  general  rule,  or 
issued  a  general  interpretation,  that  can  be  followed. 

Each  corporation  must,  therefore,  answer  the  question  for  itself. 
with  such  advice  and  information  as  may  be  available. 

This  Capital  Stock  Tax,  measured  by  fair  value  of  capital  stock, 
is  an  excise  tax  upon  the  doing  of  business  ;  so  also  was  the  Corpora- 
tion Excise  Tax  imposed  by  the  Act  of  August  5.,  1909,  even  though 
that  earlier  tax  was  measured  by  net  income.  In  their  essentials  the 
two  taxes  are  similar.  Hence,  cases  that  reached  the  Federal  Courts 
under  the  Act  of  August  5.  1909  have  a  direct  bearing  upon  the  admin- 
istration of  the  Capital  Stock  Tax. 


THE    CAPITAL    STOCK    TAX  -263 

Each  corporation  should  look  into  this  question,  for  it  is  likely 
that  some  corporations  that  have  been  paying  the  Capital  Stock  Tax 
may  find  that  they  are  not  liable  to  it ;  while  others  that  have  not  been 
paying  it  may  find  that  they  are  liable. 

The  reader  is  referred  to  the  reasoning  of  the  Supreme  Court  of 
the  United  States  in  the  case  of  Bautnbach,  Collector,  v.  Sargent  Land 
Co.,  et  al.  The  case  is  to  be  found  in  (219  Fed.  31.)  Then  it  went  be-- 
fore the  Supreme  Court  on  writ  of  certiorari  and  Mr.  Justice  Day 
delivered  the  opinion  of  the  Court.  With  respect  to  the  question  of 
"doing  business"  within  the  meaning  of  the  tax  Act,  the  Court  said: 

Were  the  respondents  carrying  on  business,  within  the  meaning  of 
the  Corporation  Tax  Act?  This  question  was  dealt  with  by  this  court 
in  the  first  of  the  Corporation  Tax  Cases,  Flint  v.  Stone  Tracy  Com- 
pany, 220  U.  S.  107.  As  the  tax  was  there  held  to  be  assessed  upon  the 
privilege  of  doing  business  in  a  coroprate  capacity,  it  became  necessary 
to  inquire  what  it  was  to  do  business,  and  this  court  adopted  with  ap- 
proval the  definition,  judicially  approved  in  other  cases,  which  included 
within  the  comprehensive  term  "business"  "that  which  occupies  the 
time,  attention  and  labor  of  men  for  the  purpose  of  a  livelihood  or 
profit." 

In  that  case  a  number  of  realty  and  mining  companies  were  dealt 
with,  and  the  Park  Realty  Company,  organized  to  deal  in  real  estate, 
and  engaged  at  the  time  in  the  management  and  leasing  of  a  certain 
hotel,  was  held  to  be  engaged  in  business.  It  was  also  held  that  the 
Clark  Iron  Company,  organized  under  the  laws  of  Minnesota,  and  own- 
ing and  leasing  ore  lands  for  the  purpose  of  carrying  on  mining  opera- 
tions, and  receiving  a  royalty  depending  upon  the  quantity  of  ore 
mined,  was  engaged  in  business. 

At  the  same  time,  and  decided  with  the  main  corporation  tax  case, 
this  court  held,  in  the  case  of  Zonne  v.  Minneapolis  Syndicate,  220  U.  S. 
187,  that  a  corporation  which  owned  a  piece  of  real  estate  which  had 
been  leased  for  130  years,  at  an  annual  rental  of  $61,000,  and  which  had 
amended  its  articles  of  incorporation  so  as  to  limit  its  purposes  to 
holding  the  title  to  the  property  mentioned,  and,  for  the  convenience 
of  its  stockholders,  to  receiving  and  distributing  from  time  to  time  the 
rentals  that  accrued  under  the  lease  and  the  proceeds  of  any  disposi- 
tion of  the  land,  was  not  engaged  in  doing  business  within  the  meaning 
of  the  act,  by  reason  of  the  fact  that  the  corporation  had  practically 
gone  out  of  business  and  had  disqualified  itself  from  any  activity  in 
respect  thereto. 

The  act  next  came  before  this  court  in  the  case  of  McCoach,  Col- 
lector, v.  Minehill  Railway  Company,  228,  U.  S.  295,  in  which  it  was 
held,  distinguishing  the  case  of  the  Park  Realty  Company,  supra,  and 
applying  the  case  of  Zonne  v.  Minneapolis  Syndicate,  supra,  to  the  facts 
before  the  court,  that  a  corporation  which  had  leased  all  its  property 
to  another,  and  was  doing  only  what  was  necessary  to  receive  and  dis- 
tribute the  income  therefrom  among  stockholders,  was  not  doing  busi- 
ness within  the  meaning  of  the  act. 

In  United  States  v.  Emery,  237  U.  S.  28,  this  court  held  that  a  cor- 
poration which  merely  kept  up  its  organization,  distributing  rent  re- 
ceived from  a  single  lessee,  was  not  doing  business  within  the  meaning 
of  the  act. 

It  is  evident,  from  what  this  court  has  said  in  dealing  with  the 
former  cases,  that  the  decision  in  each  instance  must  depend  upon  the 
particular  facts  before  the  court.  The  fair  test  to  be  derived  from  a 
consideration  of  all  of  them  is  between  a  corporation  which  has  re- 
duced its  activities  to  the  owning  and  holding  of  property  and  the  dis- 
tribution of  its  avails  and  doing  only  the  acts  necessary  to  continue 


264  THE    CAPITAL    STOCK    TAX 

that  status,  and  one  which  is  still  active  and  is  maintaining  its  organiza- 
tion for  the  purpose  of  continued  efforts  in  the  pursuit  of  profit  and 
gain  and  such  activities  as  are  essential  to  those  purposes. 

From  the  facts  clearly  established  in  these  cases,  we  think  these 
corporations  were  doing  business,  within  the  meaning  of  the  act.  They 
were  organized  for  the  purposes  stated,  and  their  activities  included 
something  more  than  the  mere  holding  of  property  and  the  distribution 
of  the  receipts  thereof.  As  was  found  by  the  District  Court,  the 
evidence  shows  that  these  three  companies  sold,  during  each  of  the 
years  named,  quantities  of  real  estate,  and  the  same  were  not  small. 
They  sold  stumpage  from  some  of  the  properties  which  had  been 
burned  over,  leased  certain  properties  in  the  village  of  Hibbing,  and 
granted  leases  to  squatters.  One  of  the  companies  made  explorations 
and  incurred  expenses  in  the  matter  of  test  pits.  They  employed 
another  company  to  see  that  the  mining  operations  were  properly  car- 
ried on,  and  that  the  lessees  lived  up  to  the  engagements  of  their  con- 
tracts. "All  these  things  indicate,"  said  the  learned  district  judge, 
"the  doing  of  and  engaging  in  business.  It  [the  corporatinn]  was  doing 
the  business  of  handling  a  large  property,  selling  lots,  and  seeing  that 
the  lessees  lived  up  to  their  contracts.  If  that  is  not  engaging  in  busi- 
ness, I  do  not  know  what  is."  We  agree  that  it  certainly  was  doing 
business,  and,  as  the  Corporation  Tax  Act  requires  no  particular 
amount  of  business  in  order  to  bring  a  company  within  its  terms, 
we  think  these  activities  brought  the  corporations  in  question  within 
that  line  of  decisions  in  this  court  which  have  held  such  corporations 
were  doing  business  in  a  corporate  capacity  within  the  meaning  of  the 
law. 

439.— FAILURE  TO  RECEIVE  FORM. 

Failure  to  receive  a  form  on  which  to  make  this  return  can  not  be 
offered  as  an  excuse  by  a  corporation  for  not  filing  a  return.  This 
question  has  come  up  many  times  and  the  Government  has  insisted 
that  the  corporation  should  have  obtained  a  form  without  awaiting 
the  receipt  of  one  by  mail.  In  all  such  cases  the  penalty  has  been  im- 
posed. 

440.— PAYMENT  OF  TAX. 

This  tax  may  be  paid  when  the  return  is  filed  in  July;  or  later, 
when  a  notice  of  assessment  is  received.  If  payment  is  deferred  until 
receipt  of  notice,  it  must  be  made  within  ten  days  of  the  date  of  the 
notice. 

441.— NO  REFUND  FOR  PART  YEAR. 

If  a  corporation  should  in  July,  1918,  pay  tax  for  the  entire  fiscal 
year  beginning  July  1,  1918,  and  should  during  that  year  go  out  OL" 
business,  it  could  not  obtain  a  refund  of  any  part  of  the  amount  paid. 


THE    ESTATE   TAX 


265 


CHAPTER  XXVIII 


ESTATE  TAX 


442.— TAX  UPON  TRANSFER. 

The  Federal  Estate  Tax  is  imposed  upon  the  transfer  of  the  net 
estate.  The  tax  is  graduated,  according  to  the  amount  of  the  net 
estate.  It  is  a  tax  which  must  be  considered  as  having  no  relation  to 
the  State  Inheritance  Tax.  Confusion  regarding  the  separation  of  the 
two  taxes — one  a  Federal  tax  and  the  other  a  State  tax — has  caused 
a  great  deal  of  trouble. 

443.— RATES  VARY  ACCORDING 
TO  DATE  OF  DEATH. 

The  Estate  Tax  was  first  imposed  by  the  Act  of  September  8, 
1916  upon  the  taxable  estates  of  decedents  dying  after  that  date. 
Then  the  rates  were  increased  by  the  Act  of  March  3,  1917,  with  re- 
spect to  the  estates  of  decedents  dying  after  that  date.  And,  again, 
the  rates  were  increased  by  the  Act  of  October  3,  1917,  with  respect 
to  the  estates  of  decedents  dying  after  that  date.  The  result  is,  there- 
fore, that  three  different  scales  of  rates  are  now  in  effect,  the  scale  to 
be  applied  depending  on  the  date  of  the  decedent's  death.  These  three 
scales  are  shown  by  the  following  table : 

Rates  of  Taxation  Upon  Net  Estates 

Sept.  9, 1916 
to  Mar.  2, 
1917,  in- 
clusive. 
Per  cent. 

Net  estate  not  exceeding  $50,000 

Net  estate  $50,000     to  $150,000 

Net  estate  $150,000  to   $250,000 

Net  estate  $250,000  to   $450,000 

Net  estate  $450,000    to    $1,000,000 

Net  estate  $1,000,000   to   $2,000,000 

Net  estate  $2000,000    to    $3,000,000 

Net  estate  $3,000,000  to   $4,000,000 

Net  estate  $4,000,000  to   $5,000,000 

Net  estate  $5,000,000   to   $8,000,000 

Net  estate  $8,000,000  to   $10,000,000 

Net  estate    exceeding    $10,000,000 


16 

Mar.  3,  1917 

On  and 

to  Oct.  3, 

after 

1917,  in- 

Oct. 4, 

clusive. 

1917. 

Per  cent. 

Per  cent. 

1 

n 

2 

2 

3 

4 

4 

4i 

6 

4 

6 

8 

5 

7i 

10 

6 

9 

12 

7 

10J 

14 

8 

12 

16 

9 

13| 

18 

10 

15 

20 

10 

15 

22 

10 

15 

25 

266  THE    ESTATE    TAX 

444.— WHEN   DEATH   DUE   TO  WAR. 

Other  than  an  increase  in  rates  the  only  change  made  by  the  Act 
of  October  3,  1917  is  an  exemption  from  the  last  increase  in  the  case 
of  a  transfer  of  the  estate  of  any  person  dying  while  in  the  military  or 
naval  service  during  the  war  or  from  injury  received  or  disease  con- 
tracted in  the  service  within  one  year  after  the  termination  of  the 
war.  This  exemption  does  not  apply,  however,  to  the  first  two  tax 
scales  shown  in  the  table  above. 

445.— EXEMPTION. 

An  exemption  of  $50,000  is  allowed  in  the  case  of  estates  of  resi- 
dents of  the  United  States ;  but  no  exemption  in  the  case  of  estates  of 
non-residents.  A  citizen  whose  residence  is  abroad  is  a  non-resident 

446.— TERRITORY  COVERED. 

Residents  of  the  Philippines  or  Porto  Rico  are  "non-residents." 
The  term  "United  States"  means  only  the  continental  States  and 
Hawaii,  Alaska  and  the  District  of  Columbia. 

447.— GROSS  ESTATE. 

The  gross  estate  includes  the  value  at  the  time  of  death   of    all 

property,  real  or  personal,  tangible  or  intangible,  wherever  situated : 

(a)  To  the  extent  of  the  decedent's  interest  at  the  time  of  death 
and  which  after  his  death  is  subject  to  payment  of  charges  against 
his  estate,  expenses  of  administration  and  distribution. 

(b)  Also  to  the  extent  of  any  interest  of  which  the  decedent  has 
made  a  transfer  at  any  time,  or  with  respect  to  which  he  has  created 
a  trust,  in  contemplation  of  or  intended  to  take  effect  at  or  after  his 
death,  except  a  bona  fide  sale  for  money  or  the  equivalent  of  money. 
Any  transfer  of  a  material  part  of  his  property  in  the  nature  of  final 
disposition,  made  "within  two  years  prior  to  death  without  such  a  con- 
sideration, will  be  regarded,  unless  the  contrary  can  be  shown,  as  hav- 
ing been  made  in  contemplation  of  death,  and,  therefore,  the  value  of 
the  property  transferred  would  be  a  part  of  the  gross  estate. 

(c)  To  the  extent  of  the  interest  therein  held  jointly  or  as  tenants 
in  the  entirety  by  the  decedent  and  any  other  person,  or  deposited  in 
banks  or  other  institutions  in  their  joint  names  and  payable  to  either 
or  the  survivor,  except  such  part  as  may  be  shown  to  have  originally 
belonged  to  such  other  person  and  never  to  have  belonged  to  the  de- 
cedent. 


THE   ESTATE   TAX  267 

448.— MISCELLANEOUS   ITEMS. 

The  value  of  all  "tax-free"  bonds — those  of  the  United  States  and 
all  others — is  a  part  of  the  gross  estate. 

Dividends  declared  prior  to  death  are  to  be  included,  whether  paid 
before  or  after  death. 

Bond  interest  accrued  up  to  the  date  of  death  is  to  be  included. 

Interest  on  mortgage  notes  and  certificates  of  deposit,  dividends 
(if  fixed  and  certain)  on  preferred  stock,  and  all  fixed  and  certain 
earnings,  must  be  included  to  the  amount  accrued  to  the  date  of  death. 

The  value  of  loans  evidenced  by  promissory  notes  is  to  be  in- 
cluded, even  though  the  will  provides  for  cancellation  of  the  notes. 

Bonds  and  stock  of  corporations  are  to  be  included.  However, 
bonds  of  a  domestic  corporation  owned  by  a  non-resident  and  kept  in 
another  country  are  not  to  be  included.' 

Community  property,  held  in  partnership  by  husband  and  wife, 
is  to  be  included  only  to  the  amount  of  one-half  of  its  value 
in  the  gross  estate  of  either  husband  or  wife.  But  if  the  wife's 
interest  is  merely  the  common  law  right  of  dower  the  whole  value 
is  to  be  included  in  the  deceased  husband's  gross  estate.  This  rule 
also  applies  where  the  husband's  interest  is  equivalent  merely  to  the 
curtesy  right. 

Insurance  paid  directly  to  the  beneficiary  named  in  the  policy  is 
not  to  be  included. 

Income  of  the  estate  and  appreciation  of  value  of  property  after 

death  are  not  to  be  included. 

• 

449.— NET  ESTATE. 

The  net  estate  is  to  be  ascertained  by  deducting  from  the  value  of 
the  gross  estate — 

(a)  Of  a  resident — 

(1)  Funeral   expenses,    administration   expenses,   claims   against 
estate,  unpaid  mortgages,  losses  from  casualty  or  theft  not 
covered  by  insurance,  support  of  decedent's  dependents  dur- 
ing settlement,  and  such  other  charges  against  the  estate  as 
are  allowed  by  the  laws  of  the  jurisdiction. 

(2)  And  an  exemption  of  $50,000. 

(b)  Of  a  non-resident — 

By  deducting  from  that  part  of  his  gross  estate  situated 
in  the  United  States  deductions  computed  in  the  proportion 


268  THE    ESTATE   TAX 

that  the  value  of  the  estate  in  the  United  States  bears  to  the 
value  of  the  entire  gross  estate.  These  deductions  are 
allowed,  however,  only  if  the  return  shows  the  entire  gross 
estate. 

450.— STATE   INHERITANCE  TAX 
NOT  DEDUCTIBLE. 

Tht  amount  paid  the  State  as  Inheritance  Tax  cannot  be  de- 
ducted in  ascertaining  net  estate.  Neither  can  the  Federal  Estate  tax, 
since  the  latter  does  not  attach  until  after  net  estate  has  been  de- 
termined. 

451.— EXECUTOR  MUST  GIVE  NOTICE. 

Within  30  days  after  qualifying  an  executor  must  give  notice  to 
the  Collector  of  Internal  Revenue  of  the  district  in  which  the  decedent 
lived.  This  notice  should  be  on  Form  704,  which  can  be  obtained  from 
the  Collector. 

452.— RETURN  AND  TAX  DUE. 

The  return  must  be  filed  on  Form  706,  and  tax  paid  within  one 
year  of  the  decedent's  death. 

A  return  must  be  made  for  every  estate  of  a  resident  with  a  gross 
value  of  $60,000,  or  with  a  net  value,  as  hereinbefore  explained,  in  ex- 
cess of  the  exemption  of  $50,000.  Return  is  required  for  the  estate  of 
a  non-resident,  whatever  the  value. 

453.— TENTATIVE  RETURN. 

If  it  is  impossible  to  file  a  complete  return  within  one  year,  the 
Collector  can  grant  an  extension  of  time  upon  the  filing  of  a  tentative 
return. 

454.— AGENT  MUST  FILE. 

The  person  in  charge  of  the  estate  of  a  non-resident  in  the  United 
States  is  required  to  file  the  return. 

455.— BENEFICIARY  MUST  FILE. 

If  there  are  no  executors  or  administrators,  or  if  any  part  of  an 
estate  does  not  pass  through  executors  or  administrators,  the  bene- 
ficiaries must  file  the  estate  return,  either  in  whole  or  in  part. 


THE    ESTATE    TAX  26Q 

456.— DISCOUNT   FOR  ADVANCE   PAYMENT. 

Although  the  tax  is  not  required  to  be  paid  until  a  year  after  the 
decedent's  death,  a  discount  at  the  rate  of  5  per  cent  per  annum  is 
allowed  for  earlier  payment,  the  discount  to  be  computed  from  the 
date  of  payment  to  the  due  date,  which  is  one  year  after  death.  This 
discount  is  based  upon  a  year  of  365  days.  To  arrive  at  it  follow  this 
formula  : 

Tax  multiplied  by  5  per  cent,  multiplied  by  the  exact  number  of 
days  from  date  of  payment  to  due  date,  divided  by  365  equals  dis- 
count. 


[Additional  instructions  relative  to  the  Estate  Tax  will  be  given 
in  the  monthly  supplement  to  this  book.] 


270  THE    STAMP    TAXES 


CHAPTER  XXIX 


STAMP  TAXES 


DOCUMENTS,    INSTRUMENTS,   TICKETS   AND   PLAYING 

CARDS. 


Title  VIII  of  the  War  Revenue  Act  of  October  3,  1917  imposes  a 
number  of  stamp  taxes  upon  documents  and  instruments  in  writing 
and  upon  steamship  tickets,  and  increases  the  tax  on  playing  cards. 
It  makes  these  stamp  taxes  effective  December  1,  1917.  On  and  after 
that  date  every  document  or  instrument  and  every  ticket  covered  by 
the  law  must  be  stamped  according  to  the  requirements  of  the  act. 
Severe  penalties  are  provided  for  failure  to  obey  the  law. 

Below  appears  the  documentary  tax  schedule,  referred  to  in  the 
statute  as  "Schedule  A — Stamp  Taxes."  After  the  taxpayer  has  noted 
the  rates  given  in  the  schedule  he  should  look  under  the  proper  head- 
ings for  the  special  instructions  relative  to  certain  documents  based 
upon  experience  in  administering  the  documentary  stamp  provisions 
of  the  Emergency  Revenue  Act  of  October  22,  1914. 

Schedule  A  of  the  War  Revenue  Act  follows : 

Schedule  A — Stamp  Taxes. 

457.— BONDS  OF  INDEBTEDNESS. 

Bonds,  debentures,  or  certificates  of  indebtedness  issued  on  and  after  De- 
cember 1,  1917  by  any  person,  corporation,  partnership  or  association,  on  each 
$100  of  face  value  or  fraction  thereof $0.05 

When  such  bonds,  debentures  or  certificates  are  renewed,  another  tax  of  5 
cents  on  the  same  basis  is  imposed. 

458.— BONDS— INDEMNITY  AND  SURETY. 

Indemnity  bonds  and  bonds  for  performance  of  contract  or  duties  of  office 
or  accounting  for  funds,  and  all  other  bonds  except  those  required  in  legal  pro- 
ceedings. 

Rate  of  tax: 

If  premium  is  charged,  then  for    each    dollar    of    premium    or 

fraction    thereof .01 

If  premium  is  not  charged,  flat  rate  for  each  bond  of ..  .50 


THE  STAMP  TAXES  271 

459.— CAPITAL  STOCK— ISSUE. 

On  original  issue  of  certificates,  whether  on  organization  or  reorgani- 
zation, on  each  $100  of  face  value  or  fraction  thereof 05 

When  certificates  are  issued  without  face,  or  par,  value  and  actual 
value  of  each  share  does  not  exceed  $100,  flat  rate  for  each  share  issued  of 05 

When  certificates  are  issued  without  face,  or  par,  value  and  actual 
value  of  each  share  does  exceed  $100,  rate  is  for  each  $100  of  actual  value 
of  each  share  or  fraction  thereof 05 

Stamps  denoting  payment  of  the  tax  should  be  affixed  to  the  stock 
books  and  not  to  the  certificates. 

460.— CAPITAL   STOCK— SALE   OR  TRANSFER. 

On  all  sales,  agreements  to  sell,  memoranda  of  sales,  or  deliveries  of, 
or  transfers  of  legal  title  to  shares  of  stock  (whether  shown  on  books  of 
company  or  effected  by  assignment  in  blank  or  evidenced  by  memoran- 
dum), on  each  $100  of  face  value  or  fraction  thereof 02 

When  shares  have  been  issued  without  face,  or  par,  value  and  the 
actual  value  of  each  share  does  not  exceed  $100,  tax  rate  is  for  each  share 02 

When  shares  have  been  issued  without  face,  or  par,  value  and  the 
actual  value  of  each  share  does  exceed  $100,  tax  rate  is  for  each  $100  of  the 
actual  value  or  fraction  thereof,  for  each  share 02 

When  evidence  of  transfer  is  shown  by  books  of  company,  stamp 
should  be  affixed  to  books;  when  change  of  ownership  is  by  transfer  of  cer- 
tificate, stamp  should  be  affixed  to  certificate;  when  transfer  is  evidenced 
by  agreement  to  sell,  or  memorandum,  or  by  delivery  of  certificate  assigned 
in  blank,  stamp  must  be  affixed  to  agreement  or  memorandum. 

Any  person,  or  any  broker,  who  makes  a  sale  or  delivers  stock,  or  de- 
livers memorandum  of  .sale  of  stock,  without  payment  of  tax  is  liable  to  a 
fine  of  $1,000,  or  six  months  in  prison,  or  both. 

461.— SALES  OF  PRODUCE  ON  EXCHANGE. 

On  each  sale,  or  agreement  to  sell  (including  the  so-called  transferred 
or  scratch  sales)  any  products  or  merchandise  on  an  exchange,  or  board  of 
trade  or  similar  place,  for  future  delivery,  for  each  $100  in  value  of  the 
merchandise 02 

And  for  each  additional  $100  in  value  or  fractional  part  thereof  in  ex- 
cess of  $100  02 

Every  sale,  or  agreement  of  sale,  or  agreement  to  sell  must  be  accom- 
panied by  a  bill  or  memorandum  or  other  evidence  of  the  sale  or  agree- 
ment, to  which  must  be  affixed  the  necessary  stamps. 

Penalty  for  violation  is  fine  not  exceeding  $1,000,  or  six  months  in 
prison,  or  both. 

462.— PROMISSORY  NOTES. 

On  every  promissory  note,  except  a  bank  note  issued  for  circulation, 
for  sum  not  exceeding  $100 02 

For  each  additional  $100  or  fraction  thereof 02 

Each  renewal  is  subject  to  a  new  tax  at  same  rate. 

Under  this  heading  also  comes  any  draft  or  check  payable  otherwise 
than  at  sight  or  on  demand. 

463.— DEEDS— CONVEYANCES. 

On  every  deed,  instrument,  or  writing,  by  which  realty  is  granted,  as- 
signed, transferred  or  otherwise  conveyed,  when,  exclusive  of  the  value  of 
any  lien  or  encumbrance  remaining  on  the  property  at  the  time  of  sale,  the 
consideration  or  value  of  the  interest  or  property  conveyed  exceeds  $100 

but  does  not  exceed  $500 50 

For  additional  $500  or  fraction  thereof 50 

No  instrument  given  to  secure  a  debt  is  taxable  under  this  provision. 


272  THE    STAMP    TAXES 

464.— CUSTOM  HOUSE  ENTRIES. 

On  each  entry  of  any  goods  at  a  custom  house,  for  either  consumption 

or  warehousing 

Not  exceeding  $100  in  value 25 

Exceeding  $100  and  not  exceeding  $500  in  value 50 

Exceeding  $500  in  value 1.00 

465.— ENTRIES   FOR  WITHDRAWAL. 

On  each  entry  for  the  withdrawal  of  any  goods  from  a  customs  bond- 
ed warehouse .-... 50 

466.— STEAMSHIP  TICKETS. 

On  each  passage  ticket,  one  way  or  round  trip,  for  each  passenger,  sold 
or  issued  in  the  United  States  for  passage  by  a  vessel  to  a  port  or  place 
not  in  the  United  States,  Canada  or  Mexico — 

Ticket  costing  more  than  $10  but  not  more  than  $30 1.00 

Ticket  costing  more  than  $30  but  not  more  than  $60 3.00 

Ticket  costing  more  than  $60 ....5.00 

A  ticket  that  does  not  cost  more  than  $10  is  exempt. 

467.— PROXIES. 

On  each  proxy  for  voting  at  any  election  for  officers,  or  meeting  for  the 
transaction  of  business  of  a  corporation,  except  religious,  educational, 
charitable,  fraternal  and  literary  societies  and  public  cemeteries 10 

468.— POWER  OF  ATTORNEY. 

On  each  power  of  attorney  granting  authority  when  such  authority  is 
not  otherwise  vested  in  the  person  to  whom  the  power  of  attorney  is  given 25 

469.— PLAYING  CARDS. 

On  each  pack  of  playing  cards,  of  not  more  than  54  cards  each,  manu- 
factured or  imported,  and  sold  or  removed  for  consumption  or  sale  after  the 
passage  of  the  act,  an  increase  of  5  cents,  making  the  tax  per  pack 07 

470.— PARCEL-POST  PACKAGES. 

On  every  parcel  or  package  sent  by  parcel  post  from  one  point  in  the 
United  States  to  another,  when  postage  amounts  to  25  cents  or  more,  the 
tax  is  for  each  25  cents  in  postage  or  fraction  thereof 01 

When  the  postage  is  less  than  25  cents  there  is  no  tax. 

When  the  postage  is  25  cents  or  more,  the  parcel  will  not  be  forwarded 
until  the  tax  is  paid  by  affixing  the  proper  stamp. 

The  consignor  must  pay  the  tax. 

471.— EXEMPTION  OF  CERTAIN  BONDS. 

The  law  specifically  exempts  from  tax  any  bond,  note  or  other 
instrument,  issued  by  the  United  States,  or  by  any  foreign  govern- 
ment, or  by  any  State,  Territory  or  the  District  of  Columbia,  or  by 
any  municipality  or  other  governmental  unit. 

It  also  exempts  both  the  stocks  and  bonds  issued  by  cooperative 
building  and  loan  associations  which  are  organized  and  operated  ex- 
clusively for  the  benefit  of  their  members  and  make  loans  only  to 
their  shareholders. 

And  it  likewise  exempts  stocks  and  bonds  issued  by  mutual  irri- 
gating companies  and  mutual  ditch  companies. 


THE    STAMP    TAXES  273 

472.— WHO  MUST  PAY  TAX. 

In  the  case  of  taxable  documents  the  Government  will  look  to  the 
maker  or  signer  for  the  tax.  Liability  attaches  primarily  to  the  per- 
son or  the  corporation  from  whom  the  document  issues.  Such  was 
the  general  rule  followed  in  the  administration  of  the  documentary 
tax  schedule  of  the  Emergency  Revenue  Act  of  October  22,  1914. 

A %  corporation  issuing  bonds  of  indebtedness  must  affix  tax 
stamps  to  the  bonds. 

The  same  is  true  with  respect  to  indemnity  and  surety  bonds. 

A  corporation  issuing  its  capital  stock  must  affix  to  its  stock 
books  stamps  denoting  payment  of  tax. 

In  the  case  of  a  sale  or  transfer  of  stock,  the  person  making  the 
sale,  or  the  broker  acting  in  the  transaction,  must  see  that  the  tax  is 
paid.  The  broker  cannot  effect  the  transfer  or  sale  without  making 
sure  that  stamps  have  been  affixed  to  the  memorandum  of  sale,  or  of 
transfer,  or  to  the  certificate  or  books,  as  directed  by  law,  and  ex- 
plained in  "Schedule  A — Stamp  Taxes,"  above. 

In  the  case  of  a  sale,  or  agreement  to  sell,  or  agreement  of  sale, 
of  products  on  an  exchange,  or  similar  institution,  such  sale  or  agree- 
ment calling  for  future  delivery,  tax  liability  attaches  to  the  seller. 
The  seller  is  required  by  law  to  make  and  deliver  to  the  buyer  a  bill, 
or  memorandum  or  other  evidence  of  the  transaction,  and  must  affix 
to  such  bill  or  memorandum  stamps  in  proper  amount. 

A  promissory  note  must  be  stamped  by  the  person  who  makes  it. 
When  it  is  renewed,  it  must  be  stamped  again  at  the  full  rate,  and 
again  liability  attaches  to  its  maker. 

A  deed  or  conveyance  of  realty  must  be  stamped  by  the  grantor. 
The  Treasury  Department  held  under  the  law  of  1914  that  the  grantor 
would  be  regarded  as  the  responsible  party,  under  the  penalties  of  the 
law,  and  the  language  of  the  present  statute  would  indicate  that  the 
same  course  must  be  followed. 

With  respect  to  custom  house  entries  the  tax  must  be  paid  by  the 
person  who  makes  the  entry. 

Tickets  for  travel  by  vessel  must  be  stamped  before  they  can  be 
presented  for  passage.  The  Government  collects  from  the  transporta- 
tion company  (the  owner  and  operator  of  the  vessels)  but  the  com- 
pany will  add  the  amount  of  the  tax  to  the  price  of  the  ticket  in  each 
case  and  require  the  passenger  to  pay  it. 

A  proxy  must  be  stamped  by  the  person  giving  it ;  a  power  of 
attorney  also  by  the  grantor. 


274  THE    STAMP    TAXES 

The  tax  on  shipment  of  parcels  and  packages  by  parcel  post  must 
be  paid  by  the  consignor. 

473.— SECONDARY  LIABILITY. 

Primary  liability  for  tax  has  been  referred  to  above  but  in  nearly 
every  case  there  is  what  might  be  termed  a  secondary  liability.  The 
law  imposes  penalty  not  only  upon  "whoever  makes,  signs  and  issues" 
any  document  or  instrument  or  paper  subject  to  tax  without  the  tax 
being  paid,  but  also  upon  "whoever  accepts"  such  document  or  paper. 
This  does  not  mean  that  the  person  primarily  liable  can  leave  payment 
of  tax  to  another.  It  does  mean  that  the  Government  can  collect  the 
tax  wherever  it  finds,  unstamped,  a  paper,  document  or  instrument 
that  should  have  been  stamped;  and  it  can  assert  the  penalty  as  cir- 
cumstances warrant. 

The  person  receiving  a  deed,  or  bond,  or  certificate  of  stock,  or 
promissory  note,  or  proxy  or  power  of  attorney,  should,  therefore, 
see  that  the  law  with  respect  to  payment  of  the  stamp  tax  has  been 
complied  with ;  otherwise,  such  person  will  become  liable  under  the 
law. 

474.— WHERE  TO  BUY  STAMPS. 

The  adhesive  stamps  with  which  these  documentary  taxes  are  to 
be  paid  can  be  purchased  from  the  office  of  the  Collector  of  Internal 
Revenue,  and  at  post-offices  and  United  States  depositary  banks.  It  is 
likely  also  that  a  great  many  other  banks  will  keep  considerable 
stocks  for  the  convenience  of  their  depositors  and  customers,  and  that 
County  Clerks  and  County  Recorders  will  have  them  on  hand. 

475.— WITH  REFERENCE  TO  CONVEYANCES. 

The  law  provides  that  its  language  shall  not  be  so  construed  as 
to  impose  a  tax  upon  any  instrument  or  writing  given  to  secure  a 
debt. 

It  also  makes  the  measure  of  the  tax  upon  a  taxable  instrument 
of  conveyance  the  consideration  or  value  of  the  interest  or  property 
conveyed  in  excess  of  any  lien  or  encumbrance  on  the  property  at  the 
time  of  sale.  If  there  is  no  consideration  capable  of  being  expressed 
in  money  terms,  there  is  no  tax. 

It  follows,  therefore,  according  to  the  Department's  rulings  un- 
der the  stamp  tax  acts  of  June  13,  1898  and  October  22,  1914,  that— 

A  deed  of  trust  is  not  subject  to  tax,  no  matter  in  what  form  it 
is  executed. 


THE    STAMP    TAXES  275 

Escrow  deeds  are  not  subject  to  tax  until  final  delivery  of  them. 

A  mere  contract  for  a  deed,  used  in  selling  real  estate,  is  not  tax- 
able. 

When  a  partition  deed  merely  defines  boundary  lines  or  shows 
each  tenant  in  common's  interest,  there  is  no  tax  due. 

A  deed  of  gift,  without  valuable  consideration,  is  not  subject  to 
tax. 

A  conveyance  of  realty  to  trustees  or  other  persons  without  valu- 
able consideration  is  not  taxable. 

A  quitclaim  deed  is  taxable  according  to  the  value  of  the  property 
interest  conveyed. 

476.— WITH  REFERENCE  TO  STOCKS  AND  BONDS. 

A  transfer  of  stock  to  a  broker  in  order  that  he  may  sell  it,  or  a 
transfer  from  a  broker  to  a  customer,  is  not  subject  to  tax,  but  the 
law  requires  that  each  such  delivery  or  transfer  be  accompanied  by  a 
certificate  reciting  the  facts. 

If  a  stockholder  surrenders  a  certificate  of  stock  and  requests  the 
issuance  of  several  certificates,  of  smaller  denomination  but  aggre- 
gating the  same  stock  interest,  there  being  no  change  of  either  in- 
terest or  ownership,  the  new  certificates  issued  by  the  corporation 
have  been  held  not  subject  to  tax. 

Certificates  of  stock  of  a  foreign  corporation  when  sold  or  de- 
livered in  the  United  States  are  liable  to  the  same  tax  as  the  stock  of 
a  domestic  corporation. 

A  bond  is  "issued,"  according  to  a  ruling  made  under  the  law  of 
1898,  "when  there  accrues  to  the  corporation  a  benefit  or  considera- 
tion for  issuing  the  same."  Then  it  becomes  subject  to  tax.  As  bonds 
issued  on  and  after  December  1,  1917  are  subject  to  tax,  it  would  seem 
proper  to  follow  the  old  ruling,  there  being  no  later  one  to  the  con- 
trary. 

477.— BONDS  REQUIRED  IN 
LEGAL  PROCEEDINGS. 

Bonds  required  in  legal  proceedings  are  not  subject  to  tax  under 
the  present  law.  The  same  exemption  was  in  the  law  of  1914.  The 
Department  then  advised  as  follows  as  to  the  line  of  demarcation 
between  bonds  which  are  required  in  legal  proceedings  and  bonds 
which  are  taxable : 

"Bonds  given  by  court  officers  under  direction  or  authority  of  the 


276  THE    STAMP    TAXES 

court  to  give  proper  effect  to  court  proceedings  and  practically  a  part 
of  the  record  of  a  suit  or  proceeding  in  court  are  not  taxable.  Bonds 
given  in  cases  of  appeal  are  not  taxable.  Bonds  given  by  executors, 
administrators,  guardians,  and  receivers  appointed  by  the  court  are 
bonds  required  in  legal  proceedings  and  are  not  taxable." 

478.— USE  OF  STOCK  AS  COLLATERAL 
NOT  SUBECT  TO  TAX. 

A  deposit  of  certificates  of  stock  as  collateral  security  for  a  loan 
does  not  call  for  payment  of  the  tax  imposed  upon  transfers  of  stock. 
This  use  of  stock  certificates  is  specifically  exempted  in  the  law. 


THE  TAX  ON  INSURANCE  POLICIES  27) 


CHAPTER  XXX 


TAX  ON  INSURANCE  POLICIES 


The  War  Revenue  Act  of  October  3,  1917  imposes  a  new  tax  upon 
policies  of  insurance. 

This  tax  became  effective  November  1,  1917  and  any  policy  issued 
on  or  after  that  date  is  subject  to  it. 

With  respect  to  the  various  lines  of  insurance  the  tax  rates  fol- 
low. 

479.— LIFE   INSURANCE. 

The  tax  is  at  the  rate  of  8  cents  on  each  $100  or  fractional  part 
thereof  of  the  amount  for  which  any  life  is  insured.  In  this  case  the 
basis  of  tax,  it  will  be  noted,  is  the  amount  of  the  insurance. 

The  one  exception  is  that  on  a  policy  for  life  insurance  only, 
issued  on  the  industrial  or  weekly  payment  plan  of  insurance,  and 
with  the  amount  of  insurance  not  in  excess  of  $500,  the  tax  rate  is 
40  per  cent  of  the  first  weekly  premium. 

480.— MARINE,   INLAND,   FIRE   INSURANCE. 

The  tax  is  at  the  rate  of  one  cent  on  each  dollar  or  fraction  there- 
of of  the  premium  charged  on  each  policy  by  which  insurance  is  made 
or  renewed  upon  property  of  any  description,  including  rents  and 
profits.  Here  the  basis  of  tax  is  the  premium. 

481.— CASUALTY  INSURANCE. 

The  tax  is  at  the  rate  of  one  cent  on  each  dollar  or  fraction  there- 
of of  the  premium  charged  on  each  policy  or  obligation  of  the  nature 
of  indemnity  for  loss,  damage  or  liability,  except  bonds  subject  to  the 
documentary  stamp  tax  under  Schedule  A  (to  be  found  described  in 
another  chapter).  This  tax  is  broad  in  its  application  and  affects  any 
person,  corporation,  partnership  or  association  engaged  in  the  writ- 
ing of  any  kind  of  insurance  except  life,  marine,  inland  and  fire  in- 
surance, which  are  subject  to  tax  as  noted  in  preceding  paragraphs. 


278  THE  TAX  ON  INSURANCE  POLICIES 

It  also  is  imposed  upon  all  policies  or  obligations  issued,  executed  or 
renewed  on  or  after  November  1,  1917. 

482.— REINSURANCE   EXEMPT. 

Policies  of  reinsurance  are  exempt  from  tax  under  all  the  provi- 
sions of  the  law. 

483.— INSURERS   EXEMPT. 

The  law  also  provides  that  any  corporation  or  association  which 
is  exempt  under  the  provisions  of  the  Income  Tax  law  of  September 
8,  1916  can  write  policies  of  insurance  without  having  such  policies 
subject  to  tax.  A  list  of  these  corporations  and  associations  can  be 
found  in  the  chapter  headed  "CORPORATIONS  EXEMPT." 

483a.— COLLECTION  OF  THE  TAX. 

The  tax  is  upon  the  issuance  of  the  policies  and  must  be  paid  by 
those  who  issue  the  policies. 

Within  the  first  15  days  of  each  month  any  person,  corporation, 
partnership,  or  association  issuing  policies  subject  to  tax,  must  make 
a  return  under  oath,  in  duplicate,  and  pay  the  tax  shown  to  be  due  to 
the  Collector  of  Internal  Revenue  of  the  district  in  which  the  prin- 
cipal office  or  place  of  business  of  the  insurer  is  located.  This  return, 
to  be  filed  not  later  than  the  fifteenth  of  the  month,  is  to  cover  tax 
liability  for  the  preceding  month. 


THE  TAX   ON  TRANSPORTATION,   ETC.  279 


CHAPTER   XXXI 


TAX  ON  TRANSPORTATION,  ETC. 


TAX  ON  TRANSPORTATION  OF  GOODS  BY  FREIGHT  AND 

EXPRESS,    ALSO    OF     PASSENGERS,    ALSO    OF    OIL 

BY    PIPE    LINE,   ALSO   ON    SEATS,   BERTHS, 

STATEROOMS,   ETC.,  AND   ON  TELE- 

GRAPH    AND    TELEPHONE 

MESSAGES. 


All  the  taxes  referred  to  in  this  chapter,  and  imposed  by  Title  V 
of  the  War  Revenue  Act  of  October  3,  1917,  are  new  with  the  excep- 
tion that  under  the  Emergency  Revenue  Act  of  October  22,  1914,  cer- 
tain items  of  the  schedule  were  covered  either  by  assessment  or  by 
levy  of  stamp  tax.  However,  the  collection  of  taxes  under  the  previ- 
ous act  having  been  terminated,  all  the  taxes  covered  by  Title  V  of 
the  present  act  can  be  regarded  as  new  taxes. 

The  effective  date  of  all  these  taxes  was  fixed  by  the  statute  as 
November  1,  1917. 

484.— TAX  ON  FREIGHT  SHIPMENT. 

The  tax  on  the  shipment  of  property  by  freight  is  3  per  cent  of 
the  amount  paid  for  transportation  by  rail  or  water  or  by  any  form 
of  mechanical  motor  power  when  such  motor  transportation  is  in 
competition  with  transportation  by  rail  or  water. 

The  tax  is  imposed  only  upon  transportation  of  freight  consigned 
from  one  point  in  the  United  States  to  another. 

485.— TAX  ON   EXPRESS  SHIPMENT. 

The  tax  on  the  shipment  of  property  by  express  is  first  restricted 
to  transportation  by  persons,  or  partnerships  or  corporations  engaged 
in  the  express  business  over  regular  routes  between  fixed  terminals. 


280  THE  TAX  ON  TRANSPORTATION,   ETC. 

The  above  condition  being  present,  the  tax  is  imposed  at  the  rate 
of  one  cent  for  each  20  cents,  or  fraction  thereof,  of  the  amount 
charged  for  the  transportation. 

And,  again,  the  shipment  must  be  from  one  point  in  the  United 
States  to  another  to  be  taxable. 

486.— TAX  ON   PASSENGER  TRANSPORTATION. 

This  tax,  with  certain  exceptions  noted  below,  is  imposed  at  the 
rate  of  8  per  cent  of  the  amount  paid  for  the  transportation. 

The  tax  may  be  considered  under  the  following  general  divisions 
with  respect  to  means  of  travel— 

(a)  By  rail  from  one  point  in  the  United  States  to  another 
or  to  any  point  in  Canada  or  Mexico,  if  the  ticket  is  sold 
or  issued  in  the  United  States. 

(b)  By  water  from  one  point  in  the  United  States  to  another 
or  to  any  point  in  Canada  or  Mexico,  if  the  ticket  is  sold 
or  issued  in  the  United  States.    In  addition  to  this  tax  on 
transportation  by  water,  there  is  provided  in  Title  VIII 
a  stamp  tax  on  tickets  for  passage  by  vessel  to  any  port 
or  place  not  in  the  United  States,  Canada  or  Mexico. 

(c)  By  motor  on  a  regular  established  line  when  in  competi- 
tion with  rail  or  water,  and  from  one  point  in  the  United 
States    to    another   or     to     any    point    in    Canada    or 
Mexico,    if   the   ticket   is   sold   or   issued   in   the   United 
States. 

487.— TAX  ON  SEATS,  BERTHS,  STATEROOMS. 

The  tax  on  seats,  berths  and  staterooms  in  parlor  cars,  sleeping 
cars,  or  on  vessels,  is  imposed  at  the  rate  of  10  per  cent  of  the  amount 
paid  for  such  accomodation. 

488.— TAX  ON  TELEGRAPH  AND  TELEPHONE. 
MESSAGES. 

The  tax  upon  telegraph,  telephone  and  radio  messages  or  con- 
versations is  at  the  flat  rate  of  5  cents  for  each  message  or  conversa- 
tion originating  within  the  United  States  and  for  which  a  charge  of 
15  cents  or  more  is  made.  This  means  that  a  message  or  conversa- 
tion costing  less  than  15  cents  is  not  subject  to  tax.  The  law  also  pro- 
vides that  the  tax  shall  be  collected  only  once  upon  any  message  or 
conversation  in  a  case  where  transmission  requires  the  use  of  the 
lines  or  stations  of  more  than  one  concern. 


THE  TAX  ON  TRANSPORTATION,   ETC.  281 

489.— TAX  ON   PIPE   LINE   TRANSPORTATION. 

The  tax  upon  the  transportation  of  oil  by  pipe  line  is  at  the  rate 
of  5  per  cent  of  the  amount  paid  for  such  transportation. 

490.— EXCEPTIONS  TO  GENERAL  TAX  RULES 

REGARDING  PASSENGER  TRANSPORTATION. 

In  the  case  of  passenger  transportation,  an  amount  paid  for  a 
commutation  or  season  ticket  for  trips  less  than  30  miles,  or  for  trans- 
portation when  the  fare  does  not  exceed  35  cents,  is  not  subject  to 
tax. 

If  a  mileage  book,  used  for  transportation  or  accomodation,  was 
purchased  before  the  tax  became  effective — that  is,  was  purchased 
prior  to  November  1,  1917 — the  conductor  or  other  agent  of  the  trans- 
portation company  must  collect  the  tax  when  the  book  is  presented 
on  or  after  November  1,  1917. 

If  the  passenger  pays  cash  fare,  instead  of  purchasing  a  ticket, 
the  conductor  or  other  agent  of  the  transportation  company  must 
collect  the  tax  when  the  fare  is  paid. 

If  a  regular  ticket — that  is,  other  than  a  mileage  book — was 
bought  and  partially  used  before  November  1,  1917,  it  is  not  subject 
to  tax  when  the  remainder  of  it  is  used  on  or  after  November  1,  1917. 

If  a  regular  ticket — that  is,  other  than  a  mileage  book — was 
bought  before  November  1,  1917,  but  was  not  used  at  all,  it  is  subject 
to  tax  when  presented  for  passage  on  or  after  November  1.  1917. 

491.— EXCEPTIONS  TO  GENERAL  TAX  RULES 

REGARDING  FREIGHT  OR  EXPRESS  SHIPMENTS. 

In  a  case  where  the  carrier  owns  the  commodity  transported,  and 
for  that  reason  or  some  other,  does  not  receive  payment  for  the  trans- 
portation, the  tax  is  to  be  collected  from  the  carrier  at  a  rate  equiva- 
lent to  the  tax  that  would  be  imposed  were  payment  received. 

However,  this  clause  does  not  mean  that  a  carrier  must  pay  tax 
upon  the  transportation  of  a  commodity  which  is  necessary  for  its 
use  in  the  carrying  business,  and  is  intended  to  be  or  has  been  so 
used.  And  neither  does  it  mean  that  one  carrier,  which  constitutes  a 
part  of  a. railroad  system,  must  pay  tax  upon  the  transportation  of 
material  for  another  carrier,  which  is  also  a  part  of  the  same  system. 

492.— PAYMENT  FOR  SERVICE  TO  GOVERNMENT 
OR  STATE  NOT  TAXABLE. 

No  tax  is  required  to  be  paid  upon  any  service  rendered  by  a  car- 
rier to  the  United  States,  or  to  any  State,  Territory,  or  the  District  of 


282  THE  TAX  ON  TRANSPORTATION,   ETC. 

Columbia.  This  includes  the  service  rendered  in  the  transportation  of 
both  freight  and  passengers,  or  express  matter.  The  exemption  also 
covers  payment  for  any  transportation  of  oil  by  pipe  line,  and  for  any 
telegraph,  telephone  or  radio  service  rendered  the  Federal,  or  a  State 
or  Territorial,  or  the  District  of  Columbia  government. 

493.— WHO  PAYS  THE  TAX. 

The  tax  must  be  paid  by  the  person,  corporation,  partnership  or 
association  paying  for  the  service  rendered.  This  rule  of  tax  liability 
is  imposed  with  respect  to  any  service  rendered  in  the  transportation 
of  freight,  express  matter,  and  passengers,  or  of  oil  by  pipe  line,  or  in 
connection  with  the  use  of  seats,  berths  and  staterooms,  or  the  means 
of  communication  afforded  by  telegraph,  telephone  and  radio  facili- 
ties. 

The  only  exceptions  to  the  rule  are  those  referred  to  in  the  first 
paragraph  under  the  heading  "Exceptions  to  General  Tax  Rules  Re- 
garding Freight  or  Express  Shipments"  and  that  exempting  from 
tax  the  payment  for  service  rendered  the  Federal  Government,  etc. 
In  the  case  of  the  first  of  these  exceptions  the  carrier  must  bear  the 
tax. 

494.— COLLECTION  OF  THE  TAX. 

Those  who  receive  payment  for  the  services  rendered  are  made 
liable  for  the  collection  of  the  tax.  Any  person,  corporation,  partner- 
ship, or  association,  receiving  any  such  payment,  must  file  monthly 
return,  under  oath,  in  duplicate,  with  the  Collector  of  Internal  Rev- 
enue of  the  district  in  which  the  principal  office  or  place  of  business  of 
the  public  utility  is  located.  The  return  must  be  made  on  an  official 
form  to  be  obtained  from  the  office  of  the  Collector. 

495.— A  DIFFERENCE  TO  NOTE. 

While  the  law  states  that  in  i:he  case  of  shipments  by  freight  or 
express  the  tax  is  to  be  collected  only  upon  payments  for  transporta- 
tion from  one  point  in  the  United  States  to  another, 

in  the  case  of  transportation  of  passengers  it  makes  the  tax  ap- 
plicable not  only  to  travel  from  one  point  in  the  United  States  to  an- 
other but  also  to  any  point  in  Canada  or  Mexico,  so  long  as  the  ticket 
is  sold  or  issued  in  the  United  States. 

This  distinction  should  be  borne  in  mind. 


THE  TAX  ON  ADMISSIONS  AND  DUES  283 


CHAPTER  XXXII 


TAX  ON  ADMISSIONS  AND  DUES 


The  new  Federal  tax  on  admissions  to  places  of  amusement,  rec- 
reation, etc.,  and  on  the  dues  or  membership  fees  (including  initiation 
fees)  paid  to  any  social,  athletic  or  sporting  club  was  made  effective 
November  1,  1917. 

496.— EXEMPTIONS. 

The  admission  tax  is  not  imposed  if  the  charge  for  admission  to 
a  place  is  not  more  than  5  cents,  or  (in  the  case  of  outdoor  general 
amusement  parks  or  shows  or  rides  within  such  parks)  is  not  more 
than  10  cents.  The  exemption  also  covers  all  admissions  where  the 
proceeds  go  exclusively  to  religious,  educational,  or  charitable  insti- 
tutions, societies  or  organizations,  or  all  admissions  to  agricultural 
fairs,  when  no  part  of  the  profits  from  such  admissions  inures  to  the 
benefit  of  any  individual  member. 

There  are  also  exempted  from  subjection  to  tax  all  dues  or  fees 
paid  to  a  fraternal  beneficiary  society,  order,  or  association,  operating 
under  the  lodge  system  or  for  the  exclusive  benefit  of  the  members  of 
a  fraternity  itself  operating  under  the  lodge  system,  and  providing 
for  the  payment  of  life,  sick,  accident,  or  other  benefits  to  the  mem- 
bers of  such  society,  order  or  association  or  their  dependents. 

497.— RATES  OF  TAX  ON  ADMISSIONS. 

With  the  exceptions  noted  above,  the  rates  of  tax  on  admissions 
are  as  follows : 

1. — One  cent  for  each  10  cents  or  fraction  thereof  of  the  amount 
paid  for  admission.  The  tax  must  also  be  collected  in  the  case  of  ad- 
mission by  season  ticket  or  subscription.  The  person  paying  for  the 
admission  must  pay  the  tax ;  the  law  says  so. 

2. — One  cent  on  admission  of  children  under  twelve  years  of  age, 
whatever  the  amount  of  the  charge  for  admission,  when  admission  is 
charged. 


284  THE  TAX  ON  ADMISSIONS  AND  DUES 

3. — One  cent  for  each  10  cents  or  fraction  thereof  of  the  regular 
admission  charge  (collected  from  others)  in  the  case  of  all  persons 
admitted  free  except  bona  fide  employees,  municipal  officers  on  official 
business  and  children  under  twelve  years  of  age.  This  means  that  if 
a  person,  who  is  not  an  employee,  an  officer  or  a  child  under  twelve, 
is  admitted  free,  he  must  nevertheless  pay  the  tax  that  he  would  have 
been  required  to  pay  had  the  proprietor  of  the  place  charged  him  the 
regular  admission  price.  The  law  places  the  tax  liability  upon  the 
person  admitted. 

4. — One  cent  for  each  10  cents  or  fraction  thereof  paid  for  admis- 
sion to  any  public  performance  for  profit  at  any  cabaret  or  other 
similar  entertainment,  where  the  charge  for  admission  is  either 
wholly  or  in  part  covered  by  the  price  paid  for  refreshment,  service, 
or  merchandise.  This  reaches  the  form  of  entertainment — cafe  or 
other  form — to  which  there  is  no  entrance  charge,  or  to  which  there 
is  a  mere  nominal  entrance  charge,  the  principal  expenditure  of  the 
patron,  in  return  for  the  entertainment  given,  being  made  within  the 
place  in  the  purchase  of  refreshments.  The  patron  of  this  form  of 
entertainment  must  bear  the  tax. 

5. — In  the  case  of  a  person  who  has  the  permanent  use  of  a  box 
or 'seat,  or  a  lease  for  the  use  of  such  box  or  seat,  in  any  opera  house 
or  place  of  amusement,  a  tax  is  to  be  collected  equivalent  to  10  per 
cent  of  the  amount  for  which  a  similar  box  or  seat  is  sold  for  the  per- 
formance or  exhibition  at  which  the  box  or  seat  is  used,  or  is  reserved 
by  or  for  the  lessee  or  holder.  And  the  lessee  or  holder  must  pay  the 
tax. 

498.— RATE  OF  TAX  ON  DUES. 

With  the  exception  with  reference  to  fraternal  and  certain  other 
societies,  hereinbefore  mentioned,  the  rate  of  tax  on  club  dues  and 
fees  is  as  follows : 

Ten  per  cent  of  the  entire  amount  of  dues  and  fees  paid  (includ- 
ing initiation  fees),  when  the  total  of  such  payments  made  by  an  in- 
dividual member  is  in  excess  of  $12  a  year.  If  the  total  does  not 
amount  to  $12  a  year,  there  is  no  tax. 

The  person  who  pays  the  dues  and  fees — the  club  member — must 
also  pay  the  tax. 

499.— COLLECTION  OF  THE  TAXES. 

The  duty  of  collecting  the  tax  on  admissions  is  placed  upon  the 
proprietors  of  the  places  of  amusement,  recreation  and  entertainment 


THE  TAX  ON  ADMISSIONS  AND   DUES  285 

to  which  admission  is  charged,  and  of  the  tax  on  dues  and  fees,  upon 
the  clubs  to  which  such  dues  and  fees  are  paid.  In  the  one  case  the 
proprietor  of  a  place  of  entertainment  must  collect  the  tax  from  his 
patron  and  in  the  other  the  club  from  its  member,  and  both  must 
make  monthly  returns,  in  duplicate,  under  oath,  and  pay  over  the 
taxes  they  have  collected  to  the  Collector  of  Internal  Revenue.  Such 
returns  are  required  to  be  made  on  an  official  form  which  should  be 
obtained  from  the  office  of  the  Collector. 


286  THE  TAX  ON  MISCELLANEOUS  ARTICLES 


CHAPTER   XXXIII 


TAX  ON  MISCELLANEOUS  ARTICLES 


WAR  EXCISE  TAXES  ON  MOTOR  VEHICLES,  MUSICAL  IN 

STRUMENTS,    PICTURE    FILMS,    SPORTING   GOODS, 

TOILET  ARTICLES,   PROPRIETARY   MEDICINES, 

CHEWING  GUM,  JEWELRY,  CAMERAS,  AND 

PLEASURE  BOATS. 


These  taxes  are  imposed  by  Title  VI  of  the  War  Revenue  Act  of 
October  3,  1917. 

They  were  effective  the  day  after  the  passage  of  the  law — or 
October  4,  1917. 

The  tax  rates  upon  the  various  vehicles  and  articles  follow. 

500.— AUTOMOBILE  AND  MOTORCYCLES. 

The  tax  is  at  the  rate  of  3  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  any  automobile,  automobile 
truck,  automobile  wagon  or  motorcycle. 

501.— PIANO  PLAYERS,  PHONOGRAPHS,  ETC. 

The  tax  is  at  the  rate  of  3  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  any  piano  player,  grapho- 
phone,  phonograph,  talking  machine  or  record  used  in  connection  with 
such  instruments. 

502.— MOVING   PICTURE   FILMS. 

The  tax  is  at  the  rate  of  one-fourth  of  one  cent  per  linear  foot  in 
the  case  of  all  films  which  have  not  been  exposed,  when  sold  by  the 
manufacturer  or  importer. 


THE  TAX  ON  MISCELLANEOUS  ARTICLES  287 

And  at  the  rate  of  one-half  of  one  cent  per  linear  foot  in  the  case 
of  positive  moving-picture  films  containing  a  picture  ready  for  pro- 
jection, when  sold  or  leased  by  the  manufacturer,  producer,  or  im- 
porter. 

503.— JEWELRY. 

The  tax  is  at  the  rate  of  3  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  any  article  commonly  or 
commercially  known  as  jewelry,  whether  real  or  imitation. 

504.— SPORTING  GOODS. 

The  tax  is  at  the  rate  of  3  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  the  following  sporting 
goods — 

Tennis  rackets  Golf  clubs 

Baseball  bats  Lacrosse  sticks 

Fishing  rods  and  reels  Billiard  and  pool  tables 

Dice  Chess  and  Checker  Boards 

and  pieces 

Balls  of  all  kinds,  including  baseballs,  foot  balls,  tennis,  golf, 
lacrosse,  billiard  and  pool  balls. 

Games  and  parts  of  games,  except  playing  cards  and  children's 
toys  and  games. 

505.— TOILET  ARTICLES. 

The  tax  is  at  the  rate  of  2  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  the  following  toilet 
articles — 

Perfumes  Toilet  waters 

Essences  Cosmetics 

Extracts  Petroleum  jellies 

Hair  oils  Pomades 

Hair  dressings  Hair  restoratives 

Tooth  and  mouth  washes  Hair  dyes 

Dentifrices  Tooth  pastes 

Toilet  soaps  and  powders  Aromatic  cachous 
Or  any  similar  article  or  preparation,  whatever  its  name,  used  for 
toilet  purposes. 

506.— PROPRIETARY  MEDICINES. 

The  tax  is  at  the  rate  of   2   per   cent   of   the  price  for  which  any 


288  THE  TAX   ON  MISCELLANEOUS   ARTICLES 

manufacturer,  producer  or  importer  sells  any  proprietary  medicine  in 
the  form  of — 

Pills  Tablets 

Powders  Tinctures 

Troches  or  lozenges  Sirups 

Anodynes  Medicinal  cordials  or  bitters 

Tonics  Plasters 

Liniments  Salves 

Ointments  Pastes 

Drops  Essences 

Spirits  Oils 

Waters,  except  those  subject  to  the  tax  imposed  upon  "soft 
drinks,"  and 

All  medicinal  preparations  or  compounds,  in  the  making  of  which 
the  manufacturer  or  producer  claims  to  follow  any  private  formula, 
secret  or  occult  art, 

Or  in  the  making  of  which  he  claims  to  have  any  exclusive  right, 

Or  which  are  made  and  offered  for  sale  under  letters  patent  or 
trade-mark, 

Or  which,  if  prepared  by  any  formula,  published  or  unpublished, 
are  offered  for  sale  as  proprietary  medicines,  or  as  remedies  or  speci- 
fics for  any  disease  or  affection  whatever  of  the  human  or  animal 
body. 

507.— CHEWING  GUM. 

The  tax  is  at  the  rate  of  2  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  any  chewing  gum  or  sub- 
stitute for  chewing  gum. 

508.— CAMERAS. 

The  tax  is  at  the  rate  of  3  per  cent  of  the  price  for  which  any 
manufacturer,  producer  or  importer  sells  any  camera. 

509.— COLLECTION  OF  THE  TAXES. 

A  monthly  return  under  oath,  in  duplicate,  must  be  made  and  the 
tax  must  be  paid  to  the  Collector  of  Internal  Revenue  by  every  manu- 
facturer, producer  or  importer  of  any  of  the  articles  enumerated  in 
the  preceding  paragraphs  of  this  chapter.  This  return  must  be  made 
in  the  district  in  which  is  located  the  principal  place  of  business  of  the 
manufacturer,  producer  or  importer.  The  official  form  for  this  return 
can  be  obtained  from  the  Collector. 


THE  TAX  ON  MISCELLANEOUS  ARTICLES  289 

510.— BASIS  OF  THE  TAXES. 

As  hereinbefore  explained,  the  basis  of  the  tax  upon  the  sale  of 
each  article  or  class  of  articles  enumerated  in  this  schedule  is  the 
price  for  which  the  manufacturer,  producer  or  importer  sells  the 
articles ;  and  liability  is  incurred  when  the  articles  are  sold. 

511.— TAX  UPON  WHOLESALE  STOCKS. 

The  act  imposes  a  tax  at  one-half  the  regular  rate  upon  stocks  of 
all  the  articles  enumerated  above,  except  moving-picture  films,  which 
on  October  4,  1917  were  held  and  intended  for  sale  by  a  wholesale 
dealer  who  is  not  the  manufacturer,  producer  or  importer. 

Under  the  law  return  under  oath  should  have  been  made  in  any 
such  case  to  the  Collector  of  Internal  Revenue  within  30  days  after 
October  3,  1917.  The  statute  provides,  however,  against  the  necessity 
of  immediate  tax  payment  by  a  clause  to  the  effect  that  payment  may 
be  deferred  for  not  more  than  seven  months  from  October  3,  1917 
upon  the  filing  of  a  bond  for  payment  with  sureties  acceptable  to  the 
Treasury  Department.  The  official  form  for  such  bond  should  be 
obtained  from  the  Collector  of  Internal  Revenue. 

Articles  sold  and  delivered  prior  to  May  9,  1917,  but  with  title  re- 
served in  the  seller  as  security  for  payment  of  the  amount  due,  are 
not  to  be  included  in  any  stock  return  made  by  a  wholesale  dealer. 

512.— TAX  UPON  PLEASURE  BOATS. 

In  the  War  Revenue  Act  is  to  be  found  a  special  excise  tax  im- 
posed upon  the  use  of  all  boats  not  used  exclusively  for  trade  or 
national  defense,  or  not  built  according  to  plans  and  specifications 
approved  by  the  Navy  Department,  provided  such  boats  come  within 
the  following  descriptions : 

(a)  Yachts,  pleasure  boats,  power  boats  and  sailing  boats,  of  over 
five  net  tons,  and 

(b)  Motor  boats  with  fixed  engines. 

513.— RATES  OF  BOAT  TAX. 

The  tax  rates  are  as  follows : 
Boats  of  over  5  net  tons — 

Length  not  over  50  feet 50  cents  for  each  foot 

Over  50  and  not  over  100  feet ..$1  for  each  foot 

Over  100  feet $2  for  each  foot 

Motor  boats  of  not  over  five  net  tons  with 

fixed    engines $5 


290  THE  TAX  ON  MISCELLANEOUS  ARTICLES 

A  motor  boat  does  not  have  to  be  of  over  five  net  tons  to  be  sub- 
ject to  tax.  If  it  is  of  over  five  net  tons,  tax  is  computed  according  to 
its  length ;  if  under,  the  flat  rate  of  $5  applies. 

Every  motor  boat,  not  used  exclusively  for  trade  or  national  de- 
fense, or  not  built  according  to  plans  and  specifications  approved  by 
the  Navy  Department,  is  taxable  if  it  has  a  fixed  engine,  whatever  its 
size. 

514.— MEASUREMENT  OF  BOATS. 

As  the  length  of  a  boat,  if  it  is  of  more  than  five  net  tons,  is  the 
basis  of  tax  computation,  the  law  provides  that  the  "over-all"  length 
shall  govern. 

515.— PAYMENT  OF  BOAT  TAX. 

This  tax  must  be  paid  by  the  user  of  the  boat  as  follows  : 
1. — First,  on  the  day  this  tax  is  made  effective, 

which  was  October  4,  1917. 
2.— And  thereafter  on  July  1  in  each  year. 
3. — Also  at  the  time  of    original  purchase  of    a 
new  boat  if  such  purchase  is  on 
a  date  other  than  July  1. 

When  tax  is  paid  at  the  time  of  original  purchase  on  a  date  other 
than  July  1,  the  amount  to  be  paid  is  the  same  number  of  twelfths  of 
the  full  rate  of  tax  as  there  are  calendar  months  (including  the  month 
of  purchase)  remaining  before  the  following  July  1.  An  example: 
Suppose  a  boat  is  purchased  February  10,  1918.  There  would  remain 
(including  the  month  of  February)  five  calendar  months  before  the 
following  July  1.  Therefore,  the  tax  that  would  be  due  would  be  five- 
twelfths  of  the  regular  rate.  But  on  the  following  July  1  tax  would 
have  to  be  paid  again  and  then  at  the  full  rate. 

516.— SHOULD  GET  OFFICIAL   FORMS. 

Every  user  of  a  boat  subject  to  tax  should  disclose  liability  to  the 
Collector  of  Internal  Revenue  and  request  the  proper  official  form  on 
which  to  make  return. 


THE    TAX    ON    LIQUORS  291 


CHAPTER  XXXIV 


TAX  ON  LIQUORS 


DISTILLED   SPIRITS,   FERMENTED 
LIQUORS,  WINES,  ETC. 


517.— OLD  AND  NEW  RATES  COMBINED. 

With  reference  to  the  taxes  on  distilled  spirits,  wines,  such  fer- 
mented liquors  as  beer,  ale  and  porter,  vermuth,  liqueurs,  cordials  and 
similar  beverages,  the  present  effective  rates,  combining  the  old  and 
new  rates,  will  be  given.  These  rates  became  effective  on  October  4, 
1917. 

518.— DISTILLED   SPIRITS. 

On  all  distilled  spirits  in  bond  on  October  4,  1917,  or  thereafter 
made  or  imported  into  the  United  States,  tax  liability  accrued  at  the 
rate  of  $2.20  on  each  proof  gallon,  or  wine  gallon  if  below  proof,  ex- 
cept that  if  such  spirits, should  be  withdrawn  from  bond  for  beverage 
purposes  or  for  use  in  the  manufacture  of  a  beverage,  the  tax  is  in- 
creased to  $3.20.  The  tax  on  such  spirits  is  payable  when  the  spirits 
are  withdrawn  from  bond.  It  is  computed  on  full  proof  gallons  and, 
proportionately,  on  fractional  parts  of  gallons. 

519.— BEER,  ALE,  PORTER  AND 

OTHER  FERMENTED   LIQUOR. 

On  beer,  ale,  porter  and  other  similar  fermented  liquor,  contain- 
ing one-half  of  1  per  cent  or  more  of  alcohol,  a  tax  at  the  rate  of  $3 
a  ba  rel  and,  proportionately,  on  fractional  parts  of  a  barrel.  A 
barrel  can  not  contain  more  than  31  gallons. 


292  THE    TAX    ON    LIQUORS 

520.— WINES,  VERMUTH,  CORDIALS,  ETC. 

On  all  still  wines,  including  vermuth,  and  on  all  champagne  and 
other  sparkling  wines,  liqueurs,  cordials,  artificial  or  imitation  wines 
or  compounds  sold  as  wines,  either  imported  or  of  domestic  produc- 
tion, if  removed  from  the  custom-house,  or  place  of  manufacture,  or 
bonded  premises  after  October  4,  1917  for  sale  or  consumption,  tax  is 
imposed  at  the  following  rates  : 

Wine  containing  not  more  than  14  per  cent 

alcohol 8  cents  a  wine  gallon 

Wine  containing  more  than  14  per  cent  but 

not  more  than  21  per  cent  alcohol 20  cents  a  wine  gallon 

Wine  containing  more  than  21  per  cent  but 

not  more  than  24  per  cent  alcohol 50  cents  a  wine  gallon 

Wine  containing  more  than  24  per  cent  al- 
cohol is  subject  to  tax  as  distilled  spirits, 
with  tax  computed  on  the  proof  gallons. 
Vermuth  is  taxed  as  a  still  wine  according 
to  its  alcoholic  strength. 

Champagne  and  natural  sparkling  wine 6  cents  a  half  pint 

Wine  artificially  carbonated 3  cents  a  half  pint 

Liqueurs,  cordials  and  similar  compounds 3  cents  a  half  pint 

521.— GRAPE   BRANDY   USED 
IN  FORTIFICATION. 

On  all  grape  brandy  or  wine  spirits  withdrawn  by  a  producer  of 
wines  from  any  fruit  distillery  or  bonded  warehouse  to  be  used  in  the 
fortification  of  wine  a  tax  at  the  rate  of  30  cents  a  proof  gallon,  if 
withdrawn  after  October  4,  1917. 

522.— RECTIFIED  PRODUCTS. 

In  addition  to  the  tax  on  distilled  spirits  there  is  also  imposed  a 
tax  at  the  rate  of  15  cents  a  proof  gallon  on  rectified  spirits  and  wines, 
provided  the  rectification  takes  place  after  October  4,  1917,  or  the 
rectified  products  were  in  the  possession  of  the  rectifier  on  that  date. 
This  tax  is  not  applicable  to  the  manufacture  of  gin  by  redistillation 
of  a  pure  spirit  over  juniper  berries  and  other  aromatics ;  nor  is  it  to 
be  imposed  in  the  case  of  the  blending  of  wines  according  to  com- 
mercial standards  or  the  blending  of  pure  straight  whiskies  aged  in 
wood  for  a  period  of  not  less  than  four  years  when  in  the  blending  of 
such  whiskies  no  other  substance  than  water  is  added  and  the  proof 
of  the  resultant  blend  is  not  below  ninetv. 


THE    TAX    ON    LIQUORS  293 

523.— PERFUMES. 

On  perfumes  containing  distilled  spirits,  imported  into  the  United 
States  after  October  4,  1917,  an  internal  revenue  tax  at  the  rate  of 
$1.10  a  proof  gallon  and,  proportionately,  on  fractional  parts  of  a 
proof  gallon,  in  addition  to  the  tax  levied  by  the  customs  authorities. 

524.— FLOOR  TAXES. 

The  above  are  the  continuing  taxes.  They  do  not  comprehend 
the  taxes  that  were  imposed  on  floor  stocks  of  distilled  spirits,  wines, 
vermuth,  cordials,  etc.,  when  the  law  to©k  effect  October  4,  1917,  or 
the  taxes  then  imposed  on  sweet  wines  held  for  sale  by  the  producer 
and  brandy  that  had  been  withdrawn  but  not  used  for  the  fortification 
of  wine.  The  returns  of  all  such  tax  liability  are  assumed  already  to 
have  been  made. 


294  THE    TAX    ON    SOFT    DRINKS 


CHAPTER  XXXV 


TAX  ON  SOFT  DRINKS 


EXTRACTS   USED   IN  THEIR  MANUFACTURE, 
AND  CARBONIC  ACID  GAS. 


525.— TAXES  ALL  NEW. 

All  the  taxes  on  the  so-called  soft  drinks  are  new  and  have  been 
in  effect  only  since  October  4,  1917.  They  are  to  be  paid  by  the  manu- 
facturer, producer  or  importer,  each  of  whom  is  required  to  make  a 
monthly  report,  or  return,  under  oath  to  the  local  Collector  of  In- 
ternal Revenue.  The  official  form  on  which  this  return  must  be  made 
can  be  obtained  from  the  Collector  by  personal  or  written  application. 

526.— TAX  ON  SOFT  DRINKS. 

The  tax  on  the  soft  drinks  is  as  follows : 

On  all  unfermented  grape  juice,  soft  drinks  or  artificial  mineral 
waters  (not  carbonated),  and  all  fermented  liquors  containing  less 
than  one-half  of  1  per  cent  alcohol,  the  tax  is  1  cent  a  gallon  when 
sold  by  the  manufacturer,  producer  or  importer,  in  bottles  or  other 
closed  containers. 

On  all  ginger  ale,  root  beer,  sarsaparilla,  pop,  and  other  carbon- 
ated waters  or  beverages,  the  tax  is  1  cent  a  gallon  when  sold  by  the 
manufacturer,  producer  or  importer  of  the  carbonic  acid  gas  used  in 
carbonating  the  beverages. 

On  all  natural  mineral  waters  or  table  waters  the  tax  is  1  cent  a 
gallon,  when  sold  by  the  producer,  bottler  or  importer,  in  bottles  or 
other  closed  containers,  at  more  than  10  cent  a  gallon. 


THE    TAX    ON    SOFT    DRINKS  295 

527.— TAX   ON   SIRUPS  AND  EXTRACTS. 

On  all  prepared  sirups  or  extracts  (intended  for  use  in  the  manu- 
facture or  production  of  soft  drinks,  by  soda  fountains,  bottling 
establishments,  and  other  similar  places)  the  tax  is  imposed  when 
sold  by  the  manufacturer,  producer  or  importer  of  such  sirups  or  ex- 
tracts according  to  the  price  for  which  sold,  as  follows : 

If  sold  for  not  more  than  $1.30  a  gallon,  a  tax  of  5  cents  a  gallon; 
if  sold  for  more  than  $1.30  but  not  more  than  $2  a  gallon,  a  tax  of  8 
cents  a  gallon ;  if  sold  for  more  than  $2  but  not  more  than  $3  a  gallon, 
a  tax  of  10  cents  a  gallon ;  if  sold  for  more  than  $3  and  not  more  than 
$4  a  gallon,  a  tax  of  15  cents  a  gallon;  if  sold  for  more  than  $4  a  gal- 
lon, a  tax  of  20  cents  a  gallon. 

528.— TAX  ON  CARBONIC  ACID  GAS. 

On  carbonic  acid  gas  in  drums  or  other  containers  (intended  for 
use  in  the  manufacture  or  production  of  carbonated  water  or  other 
drinks)  the  tax  is  5  cents  a  pound,  when  sold  by  the  manufacturer, 
producer  or  importer.  The  tax  in  this  case  must  be  paid  by  the  pur- 
chaser to  the  vendor  and  the  vendor  must  make  return  and  trans- 
mission of  the  tax  to  the  local  Collector  of  Internal  Revenue. 


296  THE   TAX    ON   TOBACCO 


CHAPTER  XXXVI 

TAX  ON  TOBACCO 


AND  ON  CIGARETTE  PAPERS 
AND  TUBES. 


529.— RATES  REPRESENT  INCREASE. 

The  present  rates  of  tax  on  cigars,  cigarettes  and  all  forms  of 
tobacco  represent  material  increase  over  the  rates  in  effect  before  the 
passage  of  the  Act  of  October  3,  1917.  They  were  made  effective  30 
days  after  the  passage  of  the  act,  or  November  2,  1917.  The  rates 
given  here  are  the  present  full  rates,  representing  both  the  old  rate 
and  the  increase.  The  manufacturer  or  importer  must  pay  the  tax. 

530.— TAX  ON  CIGARS. 

On  cigars  of  all  descriptions,  made  of  tobacco  or  any  substi- 
tute, manufactured  and  sold,  or  removed  for  consumption  or  sale,  if 
not  weighing  more  than  3  pounds  per  thousand,  the  tax  is  $1  per 
thousand. 

If  weighing  more  than  3  pounds  per  thousand,  the  tax  is  accord- 
ing to  the  following  schedule : 

If  manufactured  or  imported  to  retail  at  less  than  4  cents 
each,  the  tax  is  $3  per  thousand. 

If  manufactured  or  imported  to  retail  at  4  cents  or  more 
and  not  more  than  7  cents  each,  the  tax  is  $4  per  thousand. 

If  manufactured  or  imported  to  retail  at  more  than  7 
cents  and  not  more  than  15  cents  each,  the  tax  is  $6  per  thousand. 

If  manufactured  or  imported  to  retail  at  more  than  15 
cents  and  not  more  than  20  cents  each,  the  tax  is  $8  per  thousand. 

If  manufactured  or  imported  to  retail  at  more  than  20 
cents  each,  the  tax  is  $10  per  thousand. 

By  "retail"  is  meant  the  ardinary  retail  price  of  a  single  cigar. 


THE   TAX   ON   TOBACCO  297 

531.— TAX  ON  CIGARETTES. 

On  cigarettes  weighing  not  more  than  3  pounds  per  thousand,  the 
tax  is  $2.05  per  thousand;  if  weighing  more  than  3  pounds  per 
thousand,  the  tax  is  $4.80  per  thousand. 

532.— TAX  ON  TOBACCO  AND  SNUFF. 

On  all  tobacco  and  snuff  manufactured  and  sold,  or  removed  for 
consumption  or  use,  after  November  2,  1917,  the  tax  is  13  cents  per 
pound. 

533.— TAX  ON  CIGARETTE  PAPERS  AND  TUBES. 

On  cigarette  papers  the  tax  is  as  follows : 

(a)  On  each  package  or  book  of  more  than  25  but  not  more 
than  50  papers one-half  of  1  cent 

(b)  On  each  package  or  book  of  more  than  50  but  not  more 
than  100  papers 1  cent 

(c)  On  each  package    or   book    containing   more    than    100 
papers,  1  cent  for  each  100  or  fraction  thereof. 

On  cigarette  tubes,  2  cents  for  each    100   tubes   or    fraction 
thereof. 


298  THE    OCCUPATIONAL    TAXES 


CHAPTER   XXXVII 


SPECIAL  TAXES 


ON  OCCUPATIONS 


534.— ON  VARIOUS  OCCUPATIONS. 

The  following  so-called  Federal  Special  taxes  are  in  effect : 

Special  Taxes 


Rectifiers  of  spirits  of  less  than  500  bbls.  a  year ..$100 

Rectifiers  of  500  bbls.  or  more  a  year 200 

Wholesale  liquor  dealers ..  100 

Retail  liquor  dealers  25 

Wholesale  dealers  in  malt  liquors 50 

Retail   dealers   in   malt   liquors 20 

Manufacturers  of  stills 50 

And  for  stills  or  worms  mfg.  each ^ 20 

Brewers 

Annual  mfg.  less  than  500  bbls 50 

Annual  mfg.  500  bbls.  or  more 100 

Manufacturers   of   filled    cheese ..  400 

Whse.   dealers   in  filled   cheese 12 

Manufacturers  of  oleomargarine 600 

Whse.  dealers  in  oleo.  artificially  colored  in  imitation  of  butter 480 

Whse.  dealers  in  oleo.  free  from  art.  coloration 200 

Retail  dealers  in  oleo.  art.  colored  in  imitation  of  butter 48 

Retail  dealers  in  oleo.  free  from  art.  coloration __  6 

Manufacturers  of  adulterated  butter 600 

Wholesale  dealers  in  adulterated  butter 480 

Retail  dealers  in  adulterated  butter 48 

Manufacturers  of  process  or  renovated  butter 50 

Manufacturers,  packers  or  repackers  of  mixed  flour 12 

Brokers 30 

Pawnbrokers  50 

Customhouse  brokers  10 

Shipbrokers  20 

Proprietors  of  theatres,  museums,  or  concert  halls: 

Seating  capacity  not  over  250 25 

Seating  capacity  over  250  but  not  over  500 50 

Seating  capacity  over  500  but  not  over  800 75 

Seating  capacity  over  800 100 


THE    OCCUPATIONAL    TAXES  299 

Proprietors    of    circuses 100 

Prop,  of  public  exhibitions  not  otherwise  enumerated 10 

Prop,  of  bowling  alleys  and  billiard  rooms  (for  each  alley  or  table) 5 

Manufacturers  of  Tobacco: 

Annual  sales  not  over  50,000  Ibs 3 

Annual  sales  over  50,000  but  not  over  100,000  Ibs 6 

Annual  sales  over  100,000  but  not  over  200,000  Ibs 12 

Annual  sales  over  200,000,  for  each  1,000  Ibs.  or  fraction  thereof 08 

Manufacturers  of  Cigars: 

Annual  sales  not  over  50,000  cigars 2 

Annual  sales  over  50,000  but  not  over  100,000 3 

Annual  sales  over  100,000  but  not  over  200,000 6 

Annual  sales  over  200,000  but  not  over  400,000 12 

Annual  sales  over  400,000  cigars  for  each  additional  1000  or  fraction 05 

Manufacturers  of  Cigarettes,  for  each  10,000  or  fraction  thereof 03 


535.— MUST   BE   PAID   EACH  JULY. 

The  above  special  taxes  on  occupations  must  be  paid  each  July 
for  the  Government's  fiscal  year  beginning  July  1  of  one  year  and  end- 
ing June  30  of  the  following  year. 

536.— PENALTY  OF  50  PER  CENT. 

A  penalty  of  50  per  cent  attaches  for  failure  to  disclose  liability 
within  the  required  time.  Also  any  person  who  engages  in  a  taxable 
business  without  having  paid  the  tax  is  liable  to  prosecution. 


300  COURT    DECISIONS 


CHAPTER  XXXVIII 


COURT  DECISIONS 


UNDER  EXCISE  AND   INCOME 
TAX  LAWS 


Below  are  cited  a  number  of  decisions  that  have  touched  upon 
points  of  controversy  arising  in  connection  with  the  administration  of 
the  Income  Tax  Law  and,  before  it,  of  the  Corporation  Excise  Tax 
Law  of  August  5,  1909. 

The  headings  by  which  these  cases  are  cited  do  not,  in  any  sense, 
cover  all  the  points  at  issue.  They  do,  however,  call  attention  to 
questions  passed  upon  by  the  courts.  The  text  of  the  decisions  cannot 
be  included  in  this  book,  but  the  citations  are  made  in  such  a  way  that 
any  person  interested  should  have  no  difficulty  finding  without  delay 
any  particular  case.  If  the  decisions,  as  cited,  are  not  available,  the 
text  of  any  one  of  them  will  be  furnished  upon  written  request  to  any 
subscriber  to  this  book  and  the  monthly  supplement  to  follow  it. 

Decisions  under  the  Corporation  Excise  Tax  Act  of  August  5, 
1909  and  the  first  Income  Tax  Act  of  October  3,  1913  are  given  be- 
cause investigations  are  still  being  made  under  those  laws  and  for  the 
further  reason  that  the  decisions  are,  in  the  main,  applicable  to  the 
provisions  of  the  amended  Income  Tax  Law  of  September  8,  1916  and 
the  War  Income  Tax  Law  of  October  3,  1917,  and,  in  view  of  the  re- 
lation of  war-time  income  to  pre-war  income,  they  will  be  found  help- 
ful in  connection  with  the  Excess  Profits  Tax  problems. 

A  particular  case  should  not,  however,  be  considered  controlling 
without  first  ascertaining  whether  the  law  has  been  changed  with  re- 
spect to  the  point  in  question : 


BOOK    ENTRY    OF    DEPLETION. 

Forty  Fort  Coal  Co.  v.  Kirkendall,  Collector. 

U.  S.  District  Court,  Pa.     (233  Fed.  704) 


COURT    DECISIONS  301 

BOOKKEEPING    FACTS    DO    NOT    CONSTITUTE    INCOME. 

U.  S.  v.  Nipissing  Mines  Co. 

(202  Fed.  893) 
Mitchell  Bros.  v.  Doyle. 

(225  Fed.  437) 
Baldwin  Locomotive  Works  v.  McCoach,  Collector. 

(215  Fed.  967) 


CHANGE    OF    CAPITAL    INVESTMENT    NOT    TAXABLE. 

Lynch  v.  Hornby. 

U.  S.  Circuit  Court  of  Appeals, 
Eighth  Circuit. 


CONSTITUTIONALITY    OF    INCOME    TAX    LAW. 

Brushaber  v.  Union  Pacific  Railroad  Co. 

U.  S.  Supreme  Court  (240  U.  S.  1) 
Dodge  v.  Brady,  Collector. 

U.  S.  Supreme  Court  (240  U.  S.  122) 
Stanton  v.  Baltic  Mining  Co.  et  al 

U.  S.  Supreme  Court  (240  U.  S.  103) 
Tyee  Realty  Co.  v.  Anderson,  Collector. 

U.  S.  Supreme  Court  (240  U.  S.  115) 
Thome  v.  Anderson,  Colleetor 

U.  S.  Supreme  Court  (240  U.  S.  115) 
Dodge  v.  Osborn,  Commissioner, 

U.  S.  Supreme  Court  (240  U.  S.  118) 


CORPORATION    DISSOLVING    BEFORE    TIME    TO    MAKE    RETURN. 

U.  S.  v.  General  Inspection  &  Loading  Co. 
(192  Fed.  223) 


DEDUCTION    OF    BANK    TAX. 

Eliot  National  Bank  v.  Gill,  Collector. 

U.  S.  Circuit  Court  of  Appeals  of  the 

First  Circuit  (218  Fed.  600) 
Northern  Trust  Co.  v.  McCoach,  Collector 

(215  Fed.  991) 
Fidelity  Trust  Co.  v.  McCoach,  Collector 

(215  Fed.  996) 

Philadelphia   Trust   Safe   Deposit   &   Insurance   Company  v.   McCoach, 
Collector. 

(215  Fed.  995) 

National  Bank  of  Commerce  in  St.  Louis  v.  Allen,  Collector. 
-  (223  Fed.  472) 


DEDUCTIBLE    EXPENSES    OF    RAILROADS. 

Grand  Rapids  &  Indiana  Railway  Co.  v.  Doyle,  Collector 
U.  S.  District  Court,  Southern  Division,  Western 
District  of  Michigan. 


DIVIDENDS    PAID    BY    SUBSIDIARY    CORPORATION 
TAXABLE    TO    PARENT    CORPORATION. 

Southern  Pacific  Co.  v.  Lowe,  Collector. 

U.  S.  District  Court,  Southern  District 
of  New  York.     (238  Fed.  847) 


DIVIDENDS    PAID    BY    LESSEE,    AS    RENTAL,    DIRECT    TO    STOCKHOLD- 
ERS   OF    LESSOR  CORPORATION. 

Rensselaer  &  Saratoga  Railroad  Co.  v.  Irwin,  Collector 
U.  S.  District  Court,  Northern  District  of 
New  York     (239  Fed.  739) 


302  COURT    DECISIONS 

DIVIDENDS    OUT    OF    EARNINGS    OF    PERIOD    PRIOR    TO    JAN.    1,    1913. 
Gulf  Oil  Corporation  v.  Lewellyn,  Collector. 

U.  S.  District  Court,  Western  District  of  Pennsylvania. 


DOING    BUSINESS    UNDER    ACT    OF    AUGUST    5,    1909. 
Flint  v.  Stone  Tracy  Co. 

U.  S.  Supreme  Court  (220  U.  S.  107) 
Zonne  v.  Minneapolis  Syndicate 

U.  S.  Supreme  Court  (220  U.  S.  187) 
McCoach,  Collector,  v.  Minehill  Railway  Co. 

U.  S.  Supreme  Court  (228  U.  S.  295) 
U.  S.  v.  Emery 

U.  S.  Supreme  Court  (237  U.  S.  28) 


ENHANCED    VALUE    ACCRUED     PRIOR    TO    TAX     NOT     INCOME     UNDER 
TAX    LAW. 

Lynch  v.  Turrish. 

(236  Fed.  653) 


FORCE    OF    TAX-FREE    COVENANT    IN    BOND. 
Urquhart  v.  Marion  Hotel  Company. 

Supreme  Court  of  Kansas     (194  S.  W.  1) 


HOLDING    COMPANIES    UNDER    ACT    OF    AUGUST    5,    1909. 
Butterick  Co.  v.  U.  S. 

U.  S.  District  Court,  Southern  District  of  New  York. 
Federal  Publishing  Co.  v.  U.  S. 

U.  S.  District  Court,  Southern  District  of  New  York. 


INTEREST    RECEIVED  AND   PAID   BY    BROKERS   CARRYING   SECURITIES. 
Altheimer  &  Rawlings  Investment  Co.  v.  Allen,  Collector. 
U.  S.  District  Court,  Eastern  Division  of  the 
Eastern  District  of  Missouri. 


iNSURANCE     COMPANIES  —  INCOM  E     RETURNABLE,     RECEIPT     BY 
AGENTS,    RESERVES. 

Maryland  Casualty  Co.  v.  U.  S. 

U.  S.  Court  of  Claims. 
Mutual  Benefit  Life  Ins.  Co.  v.  Herold 

U.  S.  District  Court,  District  of  New  Jersey. 

(198  Fed.  199) 
Insurance  Company  of  North  America  v.  McCoach 

(218  Fed.  905) 
Connecticut  Mutual  Life  Ins.  Co.  v.  Eaton 

(218  Fed.  188) 


LIABILITY    OF    LESSEE,   UNDER    TERMS    OF    LEASE,    TO    PAY 
TAX    ON    RENTAL. 

Little  Schuylkill  Nav.,  R.R.  &  Coal  Co.  v.  P.  &  R.  Ry.  Co. 
Common  Pleas  Court  Philadelphia 
County.  Pa.     (44Pa.  County  Court  Reports  197) 


LIABILITY    OF    TENANT,    UNDER     LEASE    COVENANT    TO    PAY    ALL 
TAXES    ON    THE    PROPERTY,    FOR    AMOUNT    SUFFICIENT    TO 
PAY    NORMAL    TAX    OF    LANDLORD    ON     RENTAL. 
Sutter  et  al  v.  Jordan  Marsh  Co. 

Supreme  Judicial  Court  of  Mass. 
(113  N.  E.  580) 


COURT    DECISIONS  303 


MAILING    OF    ASSESSMENT    NOTICE    LEGAL. 

TL  S.  v.  General  Inspection  &  Loading  Co. 
(204  Fed.  657) 


ONLY   SUCH    GAINS   AND    PROFITS   AS   CONSTITUTE    INCOME   TAXABLE. 
Gray  v.  Darlington. 
(15  Wall  63) 


OPERATION     OF    PUBLIC    UTILITY    DOES    NOT    RELIEVE    FROM    TAX. 
Union  Hollywood  Water  Co.  v.  Carter,  Collector. 

U.  S.  Circuit  Court  of  Appeals.     (238  Fed.  329) 


RENEWAL     PREMIUMS    ON     INSURANCE     POLICIES    WRITTEN     BEFORE 
TAX    LAW    ENACTED. 

Edwards  v.  Keith,  Collector. 

U.  S.  Circuit  Court  of  Appeals  of  the 
Second  Circuit  (231  Fed.  110) 


ROYALTIES    RECEIVED    FROM     LESSEES    INCOME. 

Von  Baumbach,  Collector,  Petitioner  v.  Sargent  Land  Co. 
U.  S.  Supreme  Court.     (Date,  Jan.  15,  1917) 


SPECIFIC    EXEMPTION    IN    RELATION    TO    ADDITIONAL    TAX. 

Cohen  v.  Lowe,  Collector 

U.  S.  District  Court,  Southern  District 
of  New  York  (234  Fed.  474) 


SUIT  TO  RECOVER  TAX  BY  TERMINAL  RAILROAD  CORPORATION— THE 
DOING  OF   BUSINESS   UNDER  ACT  OF  AUGUST  5,  1909. 
Boston  Terminal  Co.  v.  Gill,  Collector. 
U.  S.  District  Court,  District  of 
Massachusetts. 


SUIT    TO     ENJOIN     COLLECTION     OF    PENALTIES. 
Kohlhamer  v.  Smietanka,  Collector. 
(239  Fed.  408) 


SUIT    BY    GOVERNMENT    TO    COLLECT    TAX — NO   LIMITATION. 

U.  S.  v.  Grand  Rapids  &  Indiana  Railway  Co. 

U.  S.  District  Court,  Southern  Division, 
Western  District  of  Michigan  (239  Fed.  153) 


SUIT    TO    RECOVER    TAXES— WHO    MUST    BE    SUED. 

Philadelphia,  Harrisburg  &  Pittsburg  Railroad 
Company  v.  Lederer,  Collector. 

U.  S.  Circuit  Court  of  Appeals  of  the  Third  Circuit. 
Roberts  v.  Lowe.  Collector. 

U.  S.  District  Court,  Southern  District  of  New  York. 


STOCK    DIVIDENDS    RESULTING    FROM    CAPITALIZATION    OF    SURPLUS 
EARNED  PRIOR  TO  JAN.  1,  1913. 
Towne  v.  Eisner,  Collector. 

U.  S.  District  Court,  Southern  District  of  New  York. 


SUIT  TO   RESTRAIN   ASSESSMENT   AND   COLLECTION    OF  TAX. 

Dodge  v.  Osborn.  Commissioner. 

U.  S.  Supreme  Court  (240  U.  S.  118) 


304  COURT    DECISIONS 

SUIT    TO    RECOVER    TAXES— TIME    LIMITATION. 

Mail  &  Newspaper  Transportation  Co.  v.  Anderson,  Collector. 
Circuit  Court  of  Appeals,  Second 
Circuit,  New  York.     (234  Fed.  590) 


TAXABILITY    OF    PROCEEDS    FROM    ORE    SALES. 
Stratton's  Independence  v.  Howbert 

U.  S.  Supreme  Court  (231  U.  S.  399) 


TAXABILITY  UNDER  ACT  OF  OCT.  3,  1913,  OF   INCOME   RECEIVED   BY 
NON-RESIDENT  ALIENS   FROM    DOMESTIC   STOCKS  AND   BONDS. 
De  Ganay  v.  Lederer,  Collector. 

U.  S.  District  Court,  Eastern  District  of 
Pennsylvania  (239  Fed.  568) 


TAXABILITY   OF   INCOME   ACCRUED   TO   PERSON    DYING   AFTER 
MARCH  1,  1913,  BUT  BEFORE  OCTOBER  3,  1913. 
Brady  et  al,  executors  v.  Anderson,  Collector. 
U.  S.  District  Court,  Southern  District 
of  New  York. 


VALUE  OF  STOCK  AS  CARRIED  ON  BOOKS. 

U.  S.  v.  Guggenheim  Exploration  Co. 

U.  S.  District  Court,  Southern  District 
of  New  York.     (238  Fed.  231) 


APPENDIX— TEXT    OF    LAW 


APPENDIX 
Containing  Text  of  Laws 


[Note:  In  the  text  of  the  Income  Tax  and  Excess  Profits  Tax 
laws  an  arbitrary  system  of  breaking  up  solid  text  and  numbering 
lines  (in  the  margin)  has  been  introduced  to  facilitate  reference  ac- 
cording to  direction  of  the  Index. 

\Yhen  the  abbreviation  (LL)  appears  in  the  Index,  the  reference 
is  to  (Law  Line  Numbers).  For  example  :  (App.  p.  2  LL  15),  in  the 
Index,  means,  (Appendix,  Page  2,  Law  Line  15)]. 


THE   INCOME  TAX. 


Act  of  September  8,  1916,  as  amended  by 
the  Act  of  October  3,  1917. 


Part  I. — On   Individuals 

1  Sec.  1.  (a)  That  there  shall  be  levied,  assessed,  collected,  and  paid 
annually  upon  the  entire  net  income  received  in  the  preceding  calendar 
year  from  all  sources 

2  by  every  individual,  a  citizen  or  resident  of  the  United  States, 

3  a  tax  of  two  per  centum  upon  such  income; 

4  and  a  like  tax  shall  be  levied,  assessed,  collected,  and  paid  annually  upon 
the  entire  net  income  received  in  the  preceding  calendar  year  from  all 
sources   within   the   United    States   by   every   individual,    a   non-resident 
alien,  including  interest  on  bonds,  notes,  or  other  interest-bearing  obliga- 
tions of  residents,  corporate  or  otherwise. 

5  (b)  In  addition  to  the  income  tax  imposed  by  subdivision  (a)  of  this 
section    (herein  referred   to   as   the  normal   tax)    there   shall  be   levied, 
assessed,  collected,  and  paid  upon  the  total  net  income  of  every  individual, 

6  or,  in  the  case  of  a  non-resident  alien,  the  total  net  income  received  from 
all  sources  within  the  United  States, 

7  an  additional  income  tax    (herein  referred  to  as  the  additional  tax)   of 

8  one  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $20,000  and  does  not  exceed  $40,000, 

9  two  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $40,000  and  does  not  exceed  $60,000, 

10     three  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $60,000  and  does  not  exceed  $80,000, 


2  APPENDIX— TEXT    OF    LA\Y 

11  four  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $80,000  and  does  not  exceed  $100,000, 

12  five  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $100,000  and  does  not  exceed  $150,000, 

13  six  per  centum   per  annum   upon  the   amount  by  which   such   total  net 
income  exceeds  $150,000  and  does  not  exceed  $200,000, 

14  seven  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $200,000  and  does  not  exceed  $250,000, 

15  eight  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $250,000  and  does  not  exceed  $300,000, 

16  nine  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $300,000  and  does  not  exceed  $500,000, 

17  ten   per   centum   per   annum   upon   the   amount  by   which   such   total   net 
income  exceeds  $500,000  and  does  not  exceed  $1,000,000, 

18  eleven  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $1,000,000  and  does  not  exceed  $1,500,000, 

19  twelve  per  centum  per  annum  upon  the  amount  by  which  such  total  net 
income  exceeds  $1,500,000  and  does  not  exceed  $2,000,000  and 

20  thirteen  per  centum  per  annum  upon  the  amount  by  which  such  total 
net  income  exceeds  $2,000,000. 

21  For  the  purpose  of  the  additional  tax  there  shall  be  included  as  in- 
come the  income  derived  from  dividends  on  the  capital  stock  or  from  the 
net  earnings  of  any  corporation,  joint-stock   company  or  association,  or 
insurance  company, 

22  except  that  in  the  case  of  non-resident  aliens  such  income  derived  from 
sources  without  the  United  States  shall  not  be  included. 

23  All  the  provisions  of  this  title  relating  to  the  normal  tax  on  indi- 
viduals, so  far  as  they  are  applicable  and  are  not  inconsistent  with  this 
subdivision  and  section  three,  shall  apply  to  the  imposition,  levy,  assess- 
ment, and  collection  of  the  additional  tax  imposed  under  this  subdivision. 

24  (c)   The    foregoing    normal    and    additional    tax    rates    shall    apply   to 
the  entire  net  income,  except  as  hereinafter  provided,  received  by  every 
taxable  person  in  the  calendar  year  nineteen  hundred  and  sixteen  and  in 
each  calendar  year  thereafter. 

25  Sec.  2.   (a)  That,  subject  only  to  such  exemptions  and  deductions  as 
are  hereinafter  allowed,  the  net  income  of  a  taxable  person  shall  include 
gains,  profits,  and  income,  derived  from 

26  salaries,  wages,  or  compensation  for  personal  service  of    whatever    kind 
and  in  whatever  form  paid, 

27  or  from  professions,  vocations,  businesses,  trade,  commerce, 

28  or  sales,  or  dealings  in  property,  whether  real  or  personal,  growing  out  of 
the  ownership  or  use  of  or  interest  in  real  or  personal  property, 

29  also  from  interest,  rent,  dividends,  securities,  or    the    transaction  of  any 
business  carried  on  for  gain  or  profit, 

30  or  gains  or  profits  and  income  derived  from  any  source  whatever. 

31  (b)   Income  received  by  estates  of  deceased  persons  during  the  period 
of  administration   or   settlement   of   the   estate,    shall   be   subject   to   the 
normal  and  additional  tax  and  taxed  to  their  estates,  and 

32  also  such  income  of  estates  or  any  kind  of  property  held  in  trust,  includ- 
ing such  income  accumulated  in  trust  for  the  benefit  of  unborn  or  un- 
ascertained  persons,   or   persons   with   contingent   interests,   and   income 
held  for  future  distribution  under  the  terms  of  the  will  or  trust  shall  be 
likew'se  taxed, 

33  the  tax  in  each  instance,  except  when  the  income  is  returned  for  the  pur- 
pose of  the  tax  by  the  beneficiary,  to  be  assessed  to  the  executor,  admin- 
istrator, or  trustee,  as  the  case  may  be: 

34  Provided,  That  where  the  income  is  to  be  distributed  annually  or 
regularly  between  existing  heirs  or  legatees,  or  beneficiaries  the 
rate  of  tax  and  method  of  computing  the  same  shall  be  based  in 
each   case  upon  the  amount  of  the   individual  share   to  be  dis- 
tributed. 

35  Such    trustees,    executors,    administrators,    and    other    fiduciaries    are 
hereby   indemnified   against  the   claims   or   demands   of  every  beneficiary 


APPENDIX— TEXT    OF    LAW  3 

for  all  payments  of  taxes  which  they  shall  be  required  to  make  under 
the  provisions  of  this  title,  and  they  shall  have  credit  for  the  amount  of 
such  payments  against  the  beneficiary  or  principal  in  any  accounting 
which  they  make  as  such  trustees  or  other  fiduciaries. 

36  (c)   For  the  purpose  of  ascertaining  the  gain  derived  from  the  sale 
or  other  disposition  of  property,  real,  personal,  or  mixed,  acquired  before 
March  first,  nineteen  hundred  and  thirteen,  the  fair  market  price  or  value 
of  such  property  as  of  March  first,  nineteen  hundred  and  thirteen,  shall 
be  the  basis  for  determining  the  amount  of  such  gain  derived. 

Additional   Tax   Includes    Undistributed    Profits 

37  Sec.  3.  For  the  purpose  of  the  additional  tax,  the  taxable  income  of 
any  individual  shall  include  the  share  to  which  he  would  be  entitled  of 
the  gains  and  profits,  if  divided  or  distributed,  whether  divided  or  dis- 
tributed or  not,  of  all  corporations,  joint-stock  companies  or  associations, 
or  insurance  companies,  however  created  or  organized,  formed  or  fraud- 
ulently availed  of  for  the  purpose  of  preventing  the  imposition  of  such 
tax  through  the  medium  of  permitting  such  gains  and  profits  to  accumu- 
late instead  of  being  divided  or  distributed; 

38  and  the  fact  that  any  such  corporation,  joint-stock  company  or  associa- 
tion, or    insurance  company,  is  a  mere  holding  company,  or  that  the  gains 
and  profits  are  permitted  to  accumulate  beyond  the  reasonable  needs  of 
the  business,  shall  be  prima  facie  evidence  of  a  fraudulent  purpose  to 
escape  such  tax; 

39  but  the  fact  that  the  gains  and  profits  are  in  any  case  permitted  to  ac- 
cumulate  and  become  surplus  shall  not  be  construed  as   evidence  of  a 
purpose  to  escape  the  said  tax  in  such  case  unless  the  Secretary  of  the 
Treasury  shall  certify  that  in  his  opinion  such  accumulation  is  unreason- 
able for  the  purposes  of  the  business. 

40  When  requested  by  the  Commissioner  of  Internal  Revenue,  or  any  district 
collector  of  internal  revenue,   such   corporation,  joint-stock   company  or 
association,  or  insurance  company  shall  forward  to  him  a  correct  state- 
ment of  such  gains  and  profits  and  the  names  and  addresses  of  the  in- 
dividuals or  shareholders  who  would  be  entitled  to  the  same  if  divided 
or  distributed. 

Income    Exempt  from    Law 

41  Sec.  4.  The  following  income  shall  be  exempt  from  the  provisions  of 
this  title: 

42  The  proceeds  of  life  insurance  policies  paid  to  individual  beneficiaries 
upon  the  death  of  the  insured;  the  amount  received  by  the  insured,  as  a 
return  of  premium  or  premiums  paid  by  him  under  life  insurance,  endow- 
ment, or  annuity  contracts,  either  during  the  term  or  at  the  maturity  of 
the  term  mentioned  in  the  contract  or  upon  surrender  of  the  contract; 

43  the  value  of  property  acquired  by  gift,  bequest,  devise,  or  descent  (but  the 
income  from  such  property  shall  be  included  as  income) ; 

44  interest  upon  the  obligations  of  a  State  or  any  political  subdivision  there- 
of or  upon  the  obligations  of  the  United  States  (but,  in  the  case  of  obliga- 
tions of  the  United  States  issued  after  September  first,  nineteen  hundred 
and  seventeen,  only  if  and  to  the  extent  provided  in  the  act  authorizing 
the  issue  thereof)   or  its  possessions  or  securities  issued  under  the  pro- 
visions of  the  Federal  Farm  Loan  Act  of  July  seventeenth,  nineteen  hun- 
dred and  sixteen; 

45  the  compensation  of  the  present  President  of  the  United  States  during  the 
term  for  which  he  has  been  elected 

46  and  the  judges  of  the  supreme  and  inferior  courts  of   the    United  States 
now  in  office, 

47  and  the  compensation  of  all  officers  and  the  employees  of  a  State,  or  any 
political  subdivision  thereof,  except  when  such  compensation  is  paid  by 
the  United  States  Government. 

Deductions    Allowed 

48  Sec.   5.  That  in   computing  net  income   in  the   case  of  a   citizen  or 
resident  of  the  United  States — 


4  APPENDIX— TEXT    OF    LAW 

49  (a)  For  the  purpose  of  the  tax  there  shall  be  allowed  as  deductions — 

50  First.     The    necessary    expenses    actually    paid    in    carrying    on    any 
business  or  trade,  not  including  personal,  living,  or  family  expenses; 

51  Second.  All  interest  paid  within  the  year  on  his  indebtedness  except 
on  indebtedness  incurred  for  the  purchase  of  obligations  or  securities  the 
interest  upon  which  is  exempt  from  taxation  as  income  under  this  title; 

52  Third.  Taxes  paid  within  the  year  imposed   by  the  authority   of   the 
United  States  (except  income  and  excess  profits  taxes)    or   of   its   Terri- 
tories, or  possessions,  or  any  foreign  country,  or  by  the  authority  of  any 
State,  county,  school  district,  or  municipality,  or  other  taxing  subdivision 
of  any  State,  not  including  those  assessed  against  local  benefits; 

53  Fourth.     Losses  actually  sustained  during  the  year,  incurred  in  his 
business  or  trade,  or  arising  from  fires,  storms,  shipwreck,  or  other  cas- 
ualty, and  from  theft,  when  such  losses  are  not  compensated  for  by  in- 
surance or  otherwise: 

54  Provided,  That  fpr  the  purpose  of  ascertaining  the  loss  sustained 
from  the  sale  or  other  disposition  of  property,  real,  personal,  or 
mixed,  acquired  before  March  first,  nineteen  hundred  and  thir- 
teen, the  fair  market  price  or  value  of  such  property  as  of  March 
first,  nineteen  hundred  and  thirteen,  shall  be  the  basis  for  deter- 
mining the  amount  of  such  loss  sustained; 

55  Fifth.     In  transactions  entered  into  for  profit  but  not  connected  with 
his  business  or  trade,   the  losses  actually   sustained   therein   during  the 
year  to  an  amount  not  exceeding  the  profits  arising  therefrom; 

56  Sixth.     Debts  due  to  the  taxpayer  actually  ascertained  to  be  worth- 
less and  charged  off  within  the  year; 

57  Seventh.     A  reasonable  allowance  for  the  exhaustion,  wear  and  tear 
of  property  arising  out  of  its  use  or  employment  in  the  business  or  trade; 

58  Eighth,     (a)  In  the  case  of  oil  and  gas  wells  a  reasonable  allowance 
for  actual  reduction  in  flow  and  production  to  be  ascertained  not  by  the 
flush  flow,  but  by  the  settled  production  or  regular  flow; 

59  (b)  in  the  case  of  mines  a  reasonable  allowance  for  depletion  thereof  not 
to  exceed  the  market  value  in  the  mine  of  the  product  thereof,  which  has 
been  mined  and  sold  during  the  year  for  which  the  return  and  computa- 
tion are  made. 

GO  such  reasonable  allowance  to  be  made  in  the  case  of  both  (a)  and  (b) 
under  rules  and  regulations  to  be  prescribed  by  the  Secretary  of  the 
Treasury: 

61  Provided,  That  when  the  allowances  authorized  in   (a)   and    (b) 
shall  equal  the  capital  originally  invested,  or  in  case  of  purchase 
made  prior  to  March  first,  nineteen  hundred  and  thirteen,  the  fair 
market  value  as  of  that  date,  no  further  allowance  shall  be  made. 

62  No  deduction  shall  be  allowed  for  any  amount  paid  out  for  new  buildings, 
permanent  improvements,  or  betterments,  made  to  increase  the  value  of 
any  property  or  estate. 

G3  and  no  deduction  shall  be  made  for  any  amount  of  expense  of  restoring 
property  or  making  good  the  exhaustion  thereof  for  which  an  allowance 
is  or  has  been  made. 

Ninth.  Contributions  or  gifts  actually  made  within  the  year  to  corpor- 
ations or  associations  organized  and  operated  exclusively  for  religious, 
charitable,  scientific,  or  educational  purposes,  or  to  societies  for  the  pre- 
vention of  cruelty  to  children  or  animals,  no  part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  individual,  to 
an  amount  not  in  excess  of  fifteen  per  centum  of  the  taxpayer's  taxable 
net  income  as  computed  without  the  benefit  of  this  paragraph.  Such  con- 
tributions or  gifts  shall  be  allowable  as  deductions  only  if  verified  under 
rules  and  regulations  prescribed  by  the  Commissioner  of  Internal  Rev- 
enue, with  the  approval  of  the  Secretary  of  the  Treasury. 
Credits  Allowed 

64  (b)  For  the  purpose  of  the  normal  tax  only,  the  income  embraced 

in  a  personal  return  shall  be  credited  with  the  amount  received  as  divi- 
dends upon  the  stock  or  from  the  net  earnings  of  any  corporation,  joint- 


APPENDIX— TEXT    OF    LAW  5 

stock  company  or  association,   trustee,  or  insurance  company,   which,  is 
taxable  upon  its  net  income  as  hereinafter  provided; 

65  (c)  A  like  credit  shall  be  allowed  as  to  the  amount  of  income,  the  nor- 
mal tax  upon  which  has  been  paid  or  withheld  for  payment  at  the  source 
of  the  income  under  the  provisions  of  this  title. 

Non-Resident   Aliens 

66  Sec.  6.     That  in  computing  net  income  in  the  case  of  a  non-resident 
alien — 

67  (a)  For  the  purpose  of  the  tax  there  shall  be  allowed  as  deductions — 

68  First.     The  necessary  expenses  actually  paid  in  carrying  on  any  busi- 
ness or  trade  conducted  by  him  within  the  United  States,  not  including 
personal,  living,  or  family  expenses; 

69  Second.  The  proportion  of  all  interest  paid  within    the  year  by  such 
person  on  his  indebtedness  (except  on  indebtedness  incurred  for  the  pur- 
chase of  obligations  or  securities  the  interest  upon  which  is  exempt  from 
taxation  as  income  under  this  title)  which  the  gross  amount  of  his  income 
for  the  year  derived  from  sources  within  the  United  States  bears  to  the 
gross  amount  of  his  income  for  the  year  derived  from  all  sources  within 
and  without  the  United  States,  but  this  deduction  shall  be  allowed  only 
if  such  person  includes  in  the  return  required  by  section  eight  all  the  in- 
formation necessary  for  its  calculation; 

70  Third.   Taxes   paid   within   the  year  imposed  by  the  authority  of  the 
United  States  (except  income  and  excess  profits  taxes),  or   of   its  Terri- 
tories, or  possessions,  or  by  the  authority  of  any  State,  county,  school  dis- 
trict, or  municipality,  or  other  taxing  subdivision  of  any  State,  paid  within 
the  United  States,  not  including  those  assessed  against  local  benefits; 

71  Fourth.     Losses  actually  sustained  during  the  year,  incurred  in  busi- 
ness or  trade  conducted  by  him  within  the  United  States,  and  losses  of 
property  within  the  United  States  arising  from  fires,  storms,  shipwreck, 
or  other  casualty,  and  from  theft,  when  such  losses  are  not  compensated 
for  by  insurance  or  otherwise: 

t  /  Provided,  That  for  the  purpose  of  ascertaining  the  amount  of  such 

Joss  or  losses  sustained  in  trade,  or  speculative  transactions  not 
in  trade,  from  the  same  or  any  kind  of  property  acquired  before 
March  first,  nineteen  hundred  and  thirteen,  the  fair  market  price 
or  value  of  such  property  as  of  March  first,  nineteen  hundred  and 
thirteen,  shall  be  the  basis  for  determining  the  amount  of  such 
loss  or  losses  sustained; 

73  Fifth.     In  transactions  entered  into  for  profit  but  not  connected  with 
his  business  or  trade,  the  losses  actually  sustained  therein  during  the 
year  to  an  amount  not  exceeding  the  profits  arising  therefrom  in  the 
United  States; 

74  Sixth.     Debts  arising  in  the  course  of  business  or  trade  conducted 
by  him  within  the  United  States  due  to  the  taxpayer  actually  ascertained 
to  be  worthless  and  charged  off  within  the  year; 

75  Seventh.    A  reasonable  allowance  for  the  exhaustion,  wear  and  tear 
of  property  within  the  United  States  arising  out  of  its  use  or  employment 
in  the  business  or  trade: 

76  (a)  in  the  case  of  oil  and  gas  wells  a  reasonable  allowance  for  actual  re- 
duction in  flow  and  production  to  be  ascertained  not  by  the  flush  flow, 
but  by  the  settled  production  or  regular  flow; 

77  (b)  in  the  case  of  mines  a  reasonable  allowance  for  depletion  thereof 
not  to  exceed  the  market  value  in  the  mine  of  the  product  thereof  which 
has  been  mined  and  sold  during  the  year  for  which  the  return  and  com- 
putation are  made, 

78  such  reasonable  allowance  to  be  made  in  the  case  of  both   (a)  and   (b) 
under  rules   and   regulations   to  be  prescribed   by  the   Secretary  of  the 
Treasury: 

79  Provided,   That  when  the  allowance   authorized   in    (a)    and    (b) 
shall  equal  the  capital  originally  invested,  or  in  case  of  purchase 


6  APPENDIX— TEXT    OF    LAAY 

made  prior  to  March  first,  nineteen  hundred  and  thirteen,  the  fair 
market  value  as  of  that  date,  no  further  allowance  shall  be  made. 

80  No  deduction  shall  be  allowed  for  any  amount  paid  out  for  new  buildings, 
permanent  improvements,  or  betterments,  made  to  increase  the  value  of 
any  property  or  estate, 

81  and  no  deduction  shall  be  made  for  any  amount  of  expense  of  restoring 
property  or  making  good  the  exhaustion  thereof  for  which  an  allowance 
is  or  has  been  made. 

82  (b)  There  shall  also  be  allowed  the  credits  specified  by  subdivisions 
(b)  and  (c)  of  section  five. 

83  (c)  A  nonresident  alien  individual  shall  receive  the  benefit  of  the  de- 
ductions and  credits  provided  for  in  this  section  only  by  filing  or  causing 
to  be  filed  with  the  Collector  of  Internal  Revenue  a  true  and  accurate  re- 
turn of  his  total  income,  received  from  all  sources,  corporate  or  otherwise, 
in  the  United  States,  in  the  manner  prescribed  by  this  title;  and  in  case 
of  his  failure  to  file  such  return  the  Collector  shall  collect  the  tax  on  such 
income,  and  all  property  belonging  to  such  nonresident  alien  individual 
shall  be  liable  to  distraint  for  the  tax. 

Personal  Exemption. 

84  Sec.  7.  That  for  the  purpose  of  the  normal  tax    only,  there    shall  be 
allowed  as  an  exemption  in  the  nature  of  a  deduction  from  the  amount  of 
the  net  income  of  each  citizen    or   resident   of   the    United  States,  ascer- 
tained as  provided  herein,  the  sum  of  $3,000, 

85  plus  $1,000  additional  if  the  person   making   the   return   be   a   head   of  a 
family  or  a  married  man  with  a  wife  living  with  him, 

86  or  plus  the  sum  of  $1,000  additional  if  the  person  making  the  return  be  a 
married  woman  with  a  husband  living  with  her; 

87  but  in  no  event  shall  this  additional  exemption  of  $1,000  be  deducted  by 
both  a  husband  and  a  wife: 

88  Provided,  That  only  one  deduction  of  $4,000  shall  be  made  from  the  aggre- 
gate income  of  both  husband  and  wife  when  living  together: 

89  Provided  further,  That  if  the  person  making  the  return  is  the  head    of   a 
family  there  shall  be  an  additional  exemption  of    $200    for  each  child  de- 
pendent upon  such  person,  if  under  eighteen  years  of  age,  or  if  incapable 
of  self-support  because  mentally  or  physically  defective,  but    this    provi- 
sion shall  operate  only  in  the  case  of  one  parent  in  the  same  family; 

90  Provided  further,  That  guardians  or  trustees  shall  be  allowed    to    make 
this  personal  exemption  as  to  income  derived  from  the  property  of  which 
such  guardian  or  trustee  has  charge  in  favor  of  each  ward  or  cestui  que 
trust: 

91  Provided  further,  That  in  no  event  shall    a    ward    or    cestui  que  trust  be 
allowed  a  greater  personal  exemption  than    as    provided    in    this    section 
from  the  amount  of  net  income  received  from  all  sources. 

92  There  shall  also  be  allowed  an  exemption  from  the  amount  of  the  net  in- 
come of  estates  of  deceased  citizens  or  residents    of    the    United    States 
during  the  period  of  administration  or  settlement, 

93  and  of  trust  or  other  estates  of  citizens  or  residents  of  the  United  States 
the  income  of  which  is  not  distributed   annually   or   regularly   under   the 
provisions  of  subdivision  (b)  of  section  two, 

94  the  sum  of  $3,000,  including  such  deductions  as  are  allowed  under  section 
five. 

Returns 

95  Sec.  8.     (a)  The  tax  shall  be  computed  upon  the  net  income,  as  thus 
ascertained,  of  each  person  subject  thereto,  received  in  each  preceding 
calendar  year  ending  December  thirty-first. 

96  (b)   On  or  before  the  first  day  of  March,  nineteen  hundred  and  seven- 
tenn,  and  the  first  day  of  March  in  each  year  thereafter,  a  true  and  ac- 
curate return  under  oath  shall  be  made  by  each  person  of  lawful  age, 
except  as  hereinafter  provided,  having  a  net  income  of  $3,000  or  over 
for  the  taxable  year 

97  to  the  collector  of  internal  revenue  for  the  district  in  which  such  person 
has  his  legal  residence  or  principal  place  of  business,  or  if  there  be  no 


APPENDIX— TEXT    OF    LAW  7 

legal  residence  or  place  of  business  in  the  United  States,  then  with  the 
collector  of  internal  revenue  at  Baltimore,  Maryland, 

98  in  such  form  as  the  Commissioner  of  Internal  Revenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  shall  prescribe,  setting  forth  specifically 
the  gross  amount  of  income  from  all  separate  sources,  and  from  the  total 
thereof  deducting  the  aggregate  items  of  allowances  herein  authorized: 

99  Provided,  That  the  Commissioner  of  Internal  Revenue  shall  have 
authority  to  grant  a  reasonable  extension  of  time,  in  meritorious 
cases,  for  filing  returns  of  income  by  persons  residing  or  travel- 
ing abroad  who  are  required  to  make  and  file  returns  of  income 
and  who  are  unable  to  file  said  returns  on  or  before  March  first 
of  each  year: 

100  Provided  further,  That  the  aforesaid  return  may  be  made  by  an 
agent  when   by  reason  of  illness,   absence,   or  non-residence   the 
person  liable  for  said  return  is  unable  to  make  and  render  the 
same,  the  agent  assuming  the  responsibility  of  making  the  return 
and  incurring  penalties  provided  for  erroneous,  false,  or  fraudu- 
lent return. 

101  (c)  Guardians,  trustees,  executors,  administrators,  receivers,  conserv- 
ators, and  all  persons,  corporations,  or  associations,  acting  in  any  fiduciary 
capacity,  shall  make  and  render  a  return  of    the  income    of    the   person, 
trust,  or  estate  for  whom  or  which  they  act,  and  be  subject  to  all  the  pro- 
visions of  this  title  which  apply  to  individuals.    Such  fiduciary  shall  make 
oath  that  he  has  sufficient  knowledge  of  the  affairs  of  such  person,  trust, 
or  estate  to  enable  him  to  make  such  return  and  that  the  same  is,  to  the 
best  of  his  knowledge  and  belief,  true  and  correct,  and  be  subject  to  all 
the  provisions  of  this  title  which  apply  to  individuals: 

102  Provided,  That  a  return  made  by  one  of  two  or  more  joint  fiduciaries  filed 
in  the  district  where  such  fiduciary  resides,  under  such  regulations  as  the 
Secretary  of  the  Treasury  may  prescribe,  shall  be  a  sufficient  compliance 
with  the  requirements  of  this  paragraph: 

103  Provided  further.  That  no  return  of  income  not  exceeding  $3.000  shall  be 
required  except  as  in  this  title  otherwise  provided. 

104  (e)  Persons  carrying  on  business  in  partnership  shall  be  liable  for  in- 
come tax  only  in  their  individual  capacity,  and  the  share  of  the  profits  of 
the  partnership  to  which  any  taxable    partner   would    be    entitled    if    the 
same  were  divided,  whether  divided  or  otherwise,  shall  be  returned  for 
taxation  and  the  tax  paid  under  the  provisions  of  this  title: 

105  Provided,  That  from  the  net  distributive  interests  on  which  the  individual 
members  shall  be  liable  for  tax,  normal  and  additional,  there  shall  be  ex- 
cluded their  pronortionate  shares  received  from  interest    on    the    obliga- 
tions of  a  State  or  any  political  or  taxing  subdivision   thereof,    and   upon 
the  obligations  of  the  United  States  (if  and  to  the  extent  that  it  is  provid- 
ed in  the  act  authorizing  the  issue  of  such  obligations  of  the  United  States 
that  they  are  exempt  from  taxation)  and  its  possessions, 

106  and  that  for  the  purpose    of    computing    the    normal    tax    there    shall    be 
allowed  a  credit,  as  provided  by  section  five,  subdivision  (b),  for  their  pro- 
portionate share  of  the  profits  derived  from  dividends. 

107  Such  partnership,  when  requested  by  the  Commissioner  of  Internal  Rev- 
enue or  any  district  collector,  shall  render  a  correct  return  of  the  earn- 
ings, profits,  and  income  of  the  partnership,  except  income  exempt  under 
section  four  of  this  Act,  setting  forth  the  item  of  the  gross  income  and  the 
deductions  and  credits  allowed  by  this  title,  and  the  names  and  addresses 
of  the  individuals  who  would  be  entitled  to  the  net  earnings,  profits,  and 
income,  if  distributed. 

108  A  partnership  shall  have  the  same  privilege  of  fixing  and  making  returns 
upon  the  basis  of  its  own  fiscal  year  as  is  accorded  to  corporations  under 
this  title. 

109  If  a  fiscal  year  ends  during  nineteen  hundred  and  sixteen  or  a  subsequent 
calendar  year  for  which  there  is  a  rate  of  tax  different  from  the  rate  for 
the  preceding  calendar  year,  then 

110  (1)  the  rate  for  such  preceding  calendar  year  shall  apply  to  an  amount  of 
each  partner's  share  of  such  partnership  profits  equal    to  the  proportion 


8  APPENDIX— TEXT    OF    LAW 

which  the  part  of  such  fiscal  year  falling  within  such  calendar  year  bears 
to  the  full  fiscal  year,  and  (2)  the  rate  for  the  calendar  year  during  whioh 
such  fiscal  year  ends  shall  apply  to  the  remainder. 

111  (f)  In  every  return  shall  be  included  the  income  derived  from  divi- 
dends on  the  capital  stock  or  from  the  net  earnings  of  any  corporation, 
joint-stock  company  or  association,  or  insurance  company, 

112  except  that  in  the  case  of  non-resident  aliens  such  income  derived  from 
sources  without  the  United  States  shall  not  be  included. 

113  (g)  An  individual  keeping  accounts  upon  any  basis  other  than  that 
of  actual  receipts  and  disbursements,  unless  such  other  basis  does  not 
clearly  reflect  his  income,  may,  subject  to  regulations  made  by  the  Com- 
missioner of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  make  his  return  upon  the  basis  upon  which  his  accounts  are 
ke,pt,  in  which  case  the  tax  shall  be  computed  upon  his  income  as  so 
returned. 

Assessment  and  Administration 

114  Sec.  9.     (a)  That  all  assessments  shall  be  made  by  the  Commissioner 
of  Internal  Revenue  and  all  persons  shall  be  notified  of  the  amount  for 
which  they  are  respectively  liable  on  or  before  the  first  day  of  June  of 
each  successive  year,  and  said  amounts  shall  be  paid  on  or  before  the 
fifteenth  day  of  June, 

115  except  in  cases  of  refusal  or  neglect  to  make  such  return  and  in 
cases  of  erroneous,  false,  or  fraudulent  returns,  in  which  cases 
the  Commissioner  of  Internal  Revenue  shall,  upon  the  discovery 
thereof,  at  any  time  within  three  years  after  said  return  is  due, 
or  has  been  made,  make  a  return  upon  information  obtained  as 
provided  for  in  this  title  or  by  existing  law,  or  require  the  neces- 
sary corrections  to  be  made,  and  the  assessment  made  by  the 
Commissioner  of  Internal  Revenue  thereon  shall  be  paid  by  such 
person  or  persons  immediately  upon  notification  of  the  amount  of 
such  assessment; 

116  and  to  any  sum  or  sums  due  and  unpaid  after  the  fifteenth  day  of  June 
in  any  year,  and  for  ten  days  after  notice  and  demand  thereof  by  the 
collector,  there  shall  be  added  the  sum  of  five  per  centum  on  the  amount 
of  tax  unpaid,  and  interest  at  the  rate  of  one  per  centum  per  month  upon 
said  tax  from  the  time  the  same  became  due,  except  from  the  estates  of 
insane,  deceased,  or  insolvent  persons. 

ill  (b)  All  persons,  corporations,  partnerships,  associations,    and    insur- 

ance companies,  in  whatever  capacity  acting,  including 

118  lessees  or  mortgagors  of  real  or  personal  property, 

119  trustees  acting  in  any  trust  capacity, 

120  executors,  administrators,  receivers,  conservators, 

121  employers, 

122  and  all  officers  and  employees  of  the  United  States 

123  having  the  control,  receipt,  custody,  disposal,  or  payment  of  interest,  rent, 
salaries,  wages,  premiums,  annuities,  compensation,  remuneration,  emolu- 
ments, or  other  fixed  or  determinable  annual  or  periodical  gains,  profits, 
and  income  of  any  nonresident  alien  individual, 

124  other  than  income  derived  from  dividends  on   capital  stock,  or   from   the 
net  earnings  of  a  corporation,  joint-stock  company  or  association,  or  in- 
surance company,  which  is  taxable  upon  its  net  income  as  provided  in  this 
title, 

125  are  hereby  authorized  and  required  to  deduct  and  withhold  from  such  an- 
nual or  periodical  gains,  profits,  and  income  such  sum  as  will  be  sufficient 
to  pay  the  normal  tax  imposed  thereon  by  this  title. 

126  and  shall  make  return  thereof  on  or  before  March  first  of  each  year  and, 
on  or  before  the  time  fixed  by  law  for  the  payment  of  the  tax,  shall  pay 
the   amount   withheld   to   the   officer   of   the   United    States   Government 
authorized  to  receive  the  same; 

127  and  they  are  each  hereby  made  personally  liable  for   such   tax,  and   they 
are  each  hereby  indemnified  against  every  person,  corporation,  partner- 
ship, association,  or  insurance    company,    or    demand  whatsoever  for  all 
payments  which  they  shall  make  in  pursuance  and  by  virtue  of  this  title. 


APPENDIX— TEXT    OF    LAW  9 

128  (c)  The  amount  of  the  normal  tax  hereinbefore  imposed  shall  also  be 
deducted  and  withheld  from  fixed  or  determinable  annual    or    periodical 
gains,  profits,  and    income    derived    from    interest  upon  bonds  and  mort- 
gages, or  deeds  of  trust  or  other  similar  obligations  of  corporations,  joint- 
stock  companies,  associations,  and  insurance  companies   (if  such  bonds, 
mortgages,  or  other  obligations  contain  a  contract  or  provision  by  which 
the  obligor  agrees  to  pay  any  portion  of  the  tax  imposed  by  this  title  upon 
the  obligee  or  to  reimburse  the  obligee  for  any  portion  of  the  tax  or  to  pay 
the  interest  without  deduction  for  any  tax  which  the  obligor  may  be  re- 
quired or  permitted  to  pay  thereon  or  to  retain  therefrom  under  any  law 
of  the  United  States), 

129  whether  payable  annually  or  at  shorter  or  longer  periods 

130  and  whether  such  interest  is  payable  to  a  nonresident  alien  individual  or 
to  an  individual  citizen  or  resident  of  the  United  States, 

131  subject  to  the  provisions  of  the  foregoing  subdivision  (b)  of  this  section 
requiring  the  tax  to  be  withheld  at  the  source  and  deducted  from  annual 
income  and  returned  and  paid  to  the  Government, 

131  unless  the  person  entitled  to  receive  such  interest  shall  file  with  the  with- 
holding agent,  on  or   before   February   first,    a   signed   notice   in   writing 
claiming  the  benefit  of  an  exemption  under  section  seven  of  this  title. 

132  (f)  All  persons,  corporations,  partnerships,  or  associations,  undertak- 
ing as  a  matter  of  business  or  for  profit  the  collection  of  foreign  payments 
of  interest  or  dividends  by  means  of  coupons,  checks,  or  bills  of  exchange 
shall  obtain  a  license  from  the  Commissioner  of  Internal  Revenue, 

133  and  shall  be  subject  to  such  regulations  enabling  the  Government  to  ob- 
tain the  information  required  under  this  title,  as  the  Commissioner  of  In- 
ternal Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury,  shall 
prescribe; 

134  and  whoever  knowingly  undertakes  to  collect  such  payments  as  aforesaid 
without  having  obtained  a  license  therefor,    or   without    complying   with 
such  regulations, 

135  shall  be  deemed  guilty  of  a  misdemeanor  and  for  each  offense  be  fined  in 
a  sum  not  exceeding  $5,000,  or  imprisoned  for  a  term   not   exceeding  one 
year,  or  both,  in  the  discretion  of  the  court. 

136  (g)  The  tax  herein  imposed  upon  gains,  profits,  and  incomes  not  fall- 
ing under  the  foregoing  and  not  returned  and  paid  by  virtue  of  the  fore- 
going or  as  otherwise  provided  by  law 

137  shall  be  assessed  by  personal  return  under  rules  and    regulations    to   be 
prescribed  by  the  Commissioner  of  Internal  Revenue  and  approved  by  the 
Secretary  of  the  Treasury. 

138  The  intent  and  purpose  of  this  title  is 

139  that  all  gains,  profits,  and  income  of  a  taxable  class,   as   defined   by  this 
title, 

140  shall  be  charged  and  assessed    with   the    corresponding  tax,  normal  and 
additional,  prescribed  by  this  title, 

141  and  said  tax  shall  be  paid  by  the  owner  of   such   income,   or   the   proper 
representative    having    the    receipt,    custody,    control,  or    disposal  of  the 
same. 

142  For  the  purpose  of  this  title  ownership  or  liability  shall  be  determined  as 
of  the  year  for  which  a  return  is  required  to  be  rendered. 

143  The  provisions  of  this  section, 

144  except  subdivision  (c),  relating  to  the  deduction  and  payment  of  the  tax 
at  the  source  of  income 

145  shall  only  apply  to  the  normal  tax  hereinbefore  imposed  upon  nonresident 
alien  individuals. 

Part    II. — On    Corporations 

146  Sec.  10.   (a)  That  there  shall  be  levied,  assessed,  collected,  and  paid 
annually  upon  the  total  net  income  received    in    the    preceding    calendar 
year  from  all  sources 

147  by  every  corporation,  joint-stock  company    or    association,    or    insurance 
company,  organized  in  the  United  States, 

148  no  matter  how  created  or  organized, 

149  but  not  including  partnerships, 


10  APPENDIX— TEXT    OF    LAW 

150  a  tax  of  two  per  centum  upon  such  income; 

151  and  a  like  tax  shall  be  levied,  assessed,  collected,  and  paid  annually  upon 
the  total  net  income  received    in  the    preceding    calendar   year    from    all 
sources  within  the  United  States 

152  by  every  corporation,    joint-stock    company    or    association,  or  insurance 
company,  organized,  authorized,  or  existing  under  the  laws  of  any  foreign 
country, 

153  including  interest  on  bonds,  notes,  or  other  interest-bearing  obligations  of 
residents,  corporate  or  otherwise, 

154  and  including  the  income  derived  from  dividends  on  capital  stock  or  from 
net  earnings  of  resident  corporations,    joint-stock    companies  or  associa- 
tions, or  insurance  companies,  whose  net  income    is    taxable    under    this 
title. 

155  The  foregoing  tax  rate  shall  apply  to  the  total  net  income  received 
by  every  taxable  corporation,  joint-stock  company  or  association,  or  in- 
surance company  in  the  calendar  year  nineteen  hundred  and  sixteen  and 
in  each  year  thereafter, 

156  except  that  if  it  has  fixed  its  own  fiscal  year  under  the  provisions  of  ex- 
isting law,  the  foregoing  rate  shall  apply  to  the  proportion  of  the  total 
net  income  returned  for  the  fiscal  year  ending  prior  to  December  thirty- 
first,  nineteen  hundred  and   sixteen,  which  the  period   between  January 
first,  nineteen  hundred  and  sixteen,  and  the  end  of  such  fiscal  year  bears 
to  the  whole  of  such  fiscal  year,  and  the  rate  [one  per  centum]  fixed  in 
Section  II  of  the  Act  approved  October  third,  nineteen  hundred  and  thir- 
teen, entitled  "An  Act  to  reduce  tariff  duties  and  to  provide  revenue  for 
the  Government,  and  for  other  purposes,"   shall  apply  to  the  remaining 
portion  of  the  total  net  income  returned  for  such  fiscal  year. 

157  For  the  purpose  of  ascertaining  the  gain  derived  or  loss  sustained 
from  the  sale  or  other  disposition  by  a  corporation,  joint-stock  company 
or    association,    or    insurance    company,    of    property,    real,    personal,    or 
mixed,  acquired  before  March  first,  nineteen  hundred  and   thirteen,  the 
fair  market  price  or  value  of  such  property  as  of  March  first  nineteen 
hundred  and  thirteen,  shall  be  the  basis  for  determining  the  amount  of 
such  gain  derived  or  loss  sustained. 

(b)  In  addition  to  the  income  tax  imposed  by  subdivision  (a)  of  this 
section  there  shall  be  levied,  assessed,  collected,  and  paid  annually  an 
additional  tax  of  ten  per  centum  upon  the  amount,  remaining  undistribut- 
ed six  months  after  the  end  of  each  calendar  or  fiscal  year,  of  the  total 
net  income  of  every  corporation,  joint-stock  company  or  association,  or  in- 
surance company,  received  during  the  year,  as  determined  for  the  pur- 
poses of  the  tax  imposed  by  such  subdivision  (a),  but  not  including  the 
amount  of  any  income  taxes  paid  by  it  within  the  year  imposed  by  the 
authority  of  the  United  States. 

The  tax  imposed  by  this  subdivision  shall  not  apply  to  that  portion  of 
such  undistributed  net  income  which  is  actually  invested  and  employed  in 
the  business  or  is  retained  for  employment  in  the  reasonable  requirements 
of  the  business  or  is  invested  in  obligations  of  the  United  States  issued 
after  September  first,  nineteen  hundred  and  seventeen:  Provided,  That  if 
the  Secretary  of  the  Treasury  ascertains  and  finds  that  any  portion  of 
such  amount  so  retained  at  any  time  for  employment  in  the  business  is 
not  so  employed  or  is  not  reasonably  required  in  the  business  a  tax  of  fif- 
teen per  centum  shall  be  levied,  assessed,  collected,  and  paid  thereon. 

The  foregoing  tax  rates  shall  apply  to  the  undistributed  net  income  re- 
ceived by  every  taxable  corporation,  joint-stock  company  or  association, 
or  insurance  company  in  the  calendar  year  nineteen  hundred  and  seven- 
teen and  in  each  year  thereafter,  except  that  if  it  has  fixed  its  own  fiscal 
year  under  the  provisions  of  existing  law,  the  foregoing  rates  shall  apply 
to  the  proportion  of  the  taxable  undistributed  net  income  returned  for  the 
fiscal  year  ending  prior  to  December  thirty-first,  nineteen  hundred  and 
seventeen,  which  the  period  between  January  first,  nineteen  hundred  and 
seventeen,  and  the  end  of  such  fiscal  year  bears  to  the  whole  of  such 
fiscal  year. 


APPENDIX— TEXT    OF    LAW  11 

Conditional    and    Other    Exemptions 

158  Sec.  11.     (a)  That  there  shall  not  be  taxed  under  this  title  any  in- 
come received  by  any — 

159  First.     Labor,  agricultural,  or  horticultural  organization; 

160  Second.     Mutual  savings  bank  not  having  a  capital  stock  represented 
by  shares; 

161  Third.     Fraternal  beneficiary  society,  order,  or  association,  operating 
under  the  lodge  system  or  for  the  exclusive  benefit  of  the  members  of  a 
fraternity  itself  operating  under  the  lodge  system,  and  providing  for  the 
payment  of  life,  sick,  accident,  or  other  benefits  to  the  members  of  such 
society,  order,  or  association  or  their  dependents; 

162  Fourth.     Domestic   building   and    loan    association    and     co-operative 
banks  without  capital  stock  organized  and  operated  for  mutual  purposes 
and  without  profit; 

163  Fifth.     Cemetery   company   owned   and   operated   exclusively  for   the 
benefit  of  its  members; 

164  Sixth.     Corporation  or  association  organized  and  operated  exclusively 
for  religious,  charitable,  scientific,  or  educational  purposes,  no  part  of  the 
net  income  of  which  inures  to  the  benefit  of  any  private  stockholder  or 
individual; 

165  Seventh.     Business  league,  chamber  of  commerce,  or  board  of  trade 
not  organized  for  profit  and  no  part  of  the  net  income  of  which  inures  to 
the  benefit  of  any  private  stockholder  or  individual; 

166  Eighth.     Civic    league    or   organization    not    organized    for    profit   but 
operated  exclusively  for  the  promotion  of  social  welfare; 

167  Ninth.     Club  organized  and  operated  exclusively  for  pleasure,  recre- 
ation, and  other  non-profitable  purposes,   no   part  of  the  net  income  of 
which  inures  to  the  benefit  of  any  private  stockholder  or  member; 

168  Tenth.     Farmers'    or    other   mutual   hail,    cyclone,    or   fire    insurance 
company,   mutual   ditch   or   irrigation    company,   mutual    or    co-operative 
telephone  company,  or  like  organization  of  a  purely  local  character,  the 
income  of  which  consists  solely  of  assessments,  dues,  and  fees  collected 
from  members  for  the  sole  purpose  of  meeting  its  expenses; 

169  Eleventh.     Farmers',   fruit   growers',    or   like   associations,    organized 
and  operated  as  a  sales  agent  for  the  purpose  of  marketing  the  products 
of  its  members  and  turning  back  to  them  the  proceeds  of  sales,  less  the 
necessary  selling  expenses,  on  the  basis  of  the  quantity  of  produce  fur- 
nished by  them; 

170  Twelfth.     Corporation    or    association    organized     for     the     exclusive 
purpose   of  holding   title   to   property,   collecting   income   therefrom,   and 
turning  over  the  entire  amount  thereof,  less  expenses,  to  an  organization 
which  itself  is  exempt  from  the  tax  imposed  by  this  title;  or 

171  Thirteenth.     Federal  land  banks  and  national  farm-loan  associations 
as  provided  in  section  twenty-six  of  the  Act  approved  July  seventeenth, 
nineteen   hundred   and    sixteen,   entitled    "An   Act   to   provide    capital   for 
agricultural  development,   to  create  standard  forms  of  investment  based 
upon   farm   mortgage,   to   equalize   rates   of   interest   upon   farm   loans,   to 
furnish  a  market  for  United   States  bonds,  to  create  Government  depos- 
itaries and  financial  agents  for  the  United  States,  and  for  other  purposes." 

172  Fourteenth.     Joint  stock  land  banks  as  to  income  derived  from  bonds 
or  debentures  of  other  joint  stock  land  banks  or  any  Federal  land  bank 
belonging  to  such  joint  stock  land  bank.  • 

173  (b)     There   shall  not  be   taxed  under  this   title  any   income   derived 
from   any   public   utility    or   from    the    exercise    of   any   essential    govern- 
mental function  accruing  to  any  State,  Territory,  or  the  District  of  Col- 
umbia, or  any  political  sub-division  of  a   State  or  Territory,  nor  any  in- 
come accruing  to  the  government  of  the  Philippine  Islands  or  Porto  Rico, 
or  of  any  political  sub-division  of  the  Philippine  Islands  or  Porto  Rico: 

174  Provided,    That   whenever   any    State,    Territory,    or   the    District 


12  APPENDIX— TEXT    OF    LAW 

of  Columbia,  or  any  political  sub-division  of  a  State  or  Territory, 
has,  prior  to  the  passage  of  this  title,  entered  in  good  faith  into  a 
contract  with  any  person  or  corporation,  the  object  and  purpose 
of  which  is  to  acquire,  construct,  operate,  or  maintain  a  public 
utility,  no  tax  shall  be  levied  under  the  provisions  of  this  title 
upon  the  income  derived  from  the  operation  of  such  public  utility, 
so  far  as  the  payment  thereof  will  impose  a  loss  or  burden  upon 
such  State,  Territory,  or  the  District  of  Columbia,  or  a  political 
sub-division  of  a  State  or  Territory; 

175  but  this  provision  is  not  intended  to  confer  upon  such  person  or 
corporation  any  financial  gain  or  exemption  or  to  relieve  such 
person  or  corporation  from  the  payment  of  a  tax  as   provided 
for  in  this  title  upon  the  part  or  portion  of  the  said  income  to 
which  such  person  or  corporation  shall  be  entitled  under  such 
contract. 

Deductions 

176  Sec.   12.     (a)  In  the   case  of  a   corporation,  joint-stock   company  or 
association,  or  insurance  company,  organized  in  the  United  States,  such 
net  income  shall  be  ascertained  by  deducting  from  the  gross  amount  of 
its  income  received  within  the  year  from  all  sources — 

177  First.     All  the  ordinary  and  necessary  expenses  paid  within  the  year 
in  the  maintenance  and  operation  of  its  business  and  properties,  including 
rentals  or  other  payments  required   to  be  made  as   a  condition  to  the 
continued  use  or  possession  of  property  to  which  the  corporation  has  not 
taken  or  is  not  taking  title,  or  in  which  it  has  no  equity. 

178  Second.     All   losses   actually   sustained   and    charged   off  within  the 
year  and  not  compensated  by  insurance  or  otherwise,  including  a  reason- 
able allowance  for  the  exhaustion,  wear  and  tear  of  property  arising  out 
of  its  use  or  employment  in  the  business  or  trade; 

179  (a)  in  the  case  of  oil  and  gas  wells  a  reasonable  allowance  for  actual  re- 
duction in  flow  and  production  to  be  ascertained  not  by  the  flush  flow,  but 
by  the  settled  production  or  regular  flow; 

180  (b)  in  the  case  of  mines  a  reasonable  allowance  for  depletion  thereof  not 
to  exceed  the  market  value  in  the  mine  of  the  product  thereof  which  has 
been  mined  and  sold  during  the  year  for  which  the  return  and  computation 
are  made, 

181  such  reasonable  allowance  to  be  made  in  the  case  of  both  (a)  and   (b) 
under  rules  and  regulations  to  be  prescribed   by  the   Secretary  of  the 
Treasury: 

182  Provided,   That  when  the  allowance  authorized   in    (a)    and    (b) 
shall  equal  the  capital  originally  invested,  or  in  case  of  purchase 
made  prior  to  March  first,  nineteen  hundred  and  thirteen,  the  fair 
market  value  as  of  that  date,  no  further  allowance  shall  be  made; 
and 

183  (c)  in  the  case  of  insurance  companies,  the  net  addition,  if  any,  required 
by  law  to  be  made  within  the  year  to  reserve  funds  and  the  sums  other 
than  dividends  paid  within  the  year  on  policy  and  annuity  contracts: 

184  Provided,  That  no  deduction  shall  be  allowed  for  any  amount  paid 
out  for  new  buildings,  permanent  improvements,  or  betterments 
made  to  increase  the  value  of  any  property  or  estate, 

185  and  no  deduction  shall  be  made  for  any  amount  of  expense  of 
restoring  property  or  making  good  the  exhaustion    thereof    for 
which  an  allowance  is  or  has  been  made: 

186  Provided  further,  That' mutual  fire  and  mutual  employers'  liability 
and    mutual   workmen's    compensation    and    mutual    casualty   in- 
surance companies  requiring  their  members  to  make  premium  de- 
posits to  provide  for  losses  and  expenses  shall  not  return  as  in- 
come  any  portion   of  the  premium   deposits   returned    to    their 
policyholders,  but  shall  return  as  taxable  income  all  income  re- 
ceived by  them  from  all  other  sources  plus  such  portions  of  the 
premium  deposits  as  are  retained  by  the  companies  for  purposes 


APPENDIX— TEXT    OF    LAW  13 

other  than  the  payment  of  losses  and  expenses  and  re-insurance 
reserves : 

187  Provided  further,  That  mutual  marine  insurance  companies  shall 
include  in  their  return  of  gross  income  gross  premiums  collected 
and  received  by  them  less  amounts  paid  for  reinsurance,  but  shall 
be  entitled  to  include  in  deductions  from  gross  income  amounts 
repaid  to  policy-holders  on  account  of  premiums  previously  paid 
by  them  and  interest  paid  upon  such  amounts  between  the  ascer- 
tainment thereof  and  the  payment  thereof, 

188  and  life  insurance  companies  shall  not  include  as  income  in  any 
year  such  portion  of  any  actual  premium  received  from  any  indi- 
vidual policyholder  as  shall  have  been  paid  back  or  credited  to 
such  individual  policyholder  or  treated  as  an  abatement  of  pre- 
mium of  such  individual  policyholder  within  such  year; 

Third.  The  amount  of  interest  paid  within  the  year  on  its  indebtedness 
(except  on  indebtedness  incurred  for  the  purchase  of  obligations  or  se- 
curities the  interest  upon  which  is  exempt  from  taxation  as  income  under 
this  title)  to  an  amount  of  such  indebtedness  not  in  excess  of  the  sum  of 
(a)  the  entire  amount  of  the  paid  up  capital  stock  outstanding  at  the  close 
of  the  year,  or,  if  no  capital  stock,  the  entire  amount  of  capital  employed 
in  the  business  at  the  close  of  the  year,  and  (b)  one-half  of  its  interest- 
bearing  indebtedness  then  outstanding: 

190  Provided,  That  for  the  purpose  of  this  title  preferred  capital  stock  shall 
not  be  considered  interest-bearing  indebtedness,  and  interest  or  dividends 
paid  upon  this  stock  shall  not  be  deductible  from  gross  income: 

191  Provided  further,  That  in  cases  wherein  shares  of  capital  stock  are  issued 
without  par  or  nominal  value,  the  amount  of  paid-up  capital  stock,  within 
the  meaning  of  this  section,  as  represented    by    such    shares,  will  be  the 
amount  of  cash,  or  its  equivalent,  paid  or  transferred  to  the  corporation 
as  a  consideration  for  such  shares: 

192  Provided    further,    That    in   the    case    of   indebtedness  wholly  secured  by 
property  collateral,  tangible  or  intangible,  the  subject  of  sale  or  hypothe- 
cation in  the  ordinary  business  of  such  corporation,  joint-stock  company 
or  association  as  a  dealer  only  in  the  property  constituting  such  collateral, 
or  in  loaning  the  funds  thereby  procured,  the  total  interest  paid  by  such 
corporation,  company,  or  association  within  the  year  on  any  such  indebt- 
edness may  be  deducted  as  a  part  of  its  expenses  of  doing  business,  but 
interest  on  such  indebtedness  shall  only  be  deductible  on   an    amount  of 
such  indebtedness  not  in  excess  of  the  actual  value  of  such  property  col- 
lateral : 

193  Provided  further,  That  in  the  case  of  bonds  or  other  indebtedness,  which 
have  been  issued  with  a  guaranty  that  the  interest  payable  thereon  shall 
be  free  from  taxation,  no  deduction  for  the  payment  of  the  tax  herein  im- 
posed, or  any  other  tax  paid  pursuant  to  such  guaranty,  shall  be  allowed; 

194  and  in  the  case  of  a  bank,  banking  association,  loan  or  trust  company,  in- 
terest paid  within  the  year  on  deposits  or  on  moneys  received  for  invest- 
ment and  secured  by  interest-bearing  certificates  of  indebtedness  issued 
by  such  bank,  banking  association,  loan    or    trust    company    shall    be    de- 
ducted; 

Fourth.  Taxes  paid  within  the  year  imposed  by  the  authority  of  the 
United  States  (except  income  and  excess  profits  taxes),  or  of  its  Terri- 
tories, £>r  possessions,  or  any  foreign  country,  or  by  the  authority  of  any 
State,  county,  school  district,  or  municipality,  or  other  taxing  subdivision 
of  any  State,  not  including  those  assessed  against  local  benefits. 

(b)  In  the  case  of  a  corporation,  joint-stock  company  or  associa- 
tion, or  insurance  company,  organized,  authorized,  or  existing  under  the 
laws  of  any  foreign  country,  such  net  income  shall  be  ascertained  by  de- 
ducting from  the  gross  amount  of  its  income  received  within  the  year 
from  all  sources  within  the  United  States — 

First.  All  the  ordinary  and  necessary  expenses  paid  within  the  year 
out  of  earnings  in  the  maintenance  and  operation  of  its  business  and 
property  within  the  United  States,  including  rentals  or  other  payments 


14  APPENDIX— TEXT    OF    LAW 

required  to  be  made  as  a  condition  to  the  continued  use  or  possession 
of  property  to  which  the  corporation  has  not  taken  or  is  not  taking  title, 
or  in  which  it  has  no  equity. 

198  Second.     All  losses  actually  sustained  within  the  year  in  business  or 
trade  conducted  by  it  within  the  United  States  and  not  compensated  by 
insurance    or   otherwise,    including   a    reasonable    allowance    for   the    ex- 
haustion, wear  and  tear  of  property  arising  out  of  its  use  or  employment 
in  the  business  or  trade; 

199  (a)     and  in  the   case  of  oil  and   gas  wells   a   reasonable  allowance  for 
actual  reduction  in  flow  and  production  to  be  ascertained  not  by  the  flush 
flow,  but  by  the  settled  production  or  regular  flow, 

200  (b)     In  the  case  of  mines  a  reasonable  allowance  for  depletion  thereof 
not  to  exceed  the  market  value  in  the  mine  of  the  product  thereof  which 
has  been  mined  and  sold  during  the  year  for  which  the  return  and  com- 
putation are  made, 

201  such  reasonable  allowance  to  be  made  in  the  case  of  both   (a)   and    (b) 
under  rules   and   regulations   to   be   prescribed   by   the   Secretary   of  the 
Treasury: 

202  Provided,   That  when  the  allowance   authorized   in    (a)    and    (b) 
shall  equal  the  capital  originally  invested,  or  in  case  of  purchase 
made  prior   to   March   first,   nineteen  hundred  and   thirteen,   the 
fair   market   value   as    of   that   date,    no    further   allowance    shall 
be  made;  and 

203  (c)     in  the  case  of  insurance  companies,  the  net  addition,  if  any,  required 
by  law  to  be  made  within  the  year  to  reserve  funds  and  the  sums  other 
than  dividends  paid  within  the  year  on  policy  and  annuity  contracts: 

204  Provided,     That  no   deduction   shall   be   allowed   for  any  amount 
paid  out  for  new  buildings,  permanent  improvements,  or  better- 
ments, made  to  increase  the  value  of  any  property  or  estate, 

205  and  no  deduction  shall  be  made  for  any  amounts  of  expense  of 
restoring   property   or   making   good    the   exhaustion   thereof   for 
which  an  allowance  is  or  has  been  made: 

206  Provided,   further.    That   mutual   fire   and   mutual    employers'   lia- 
bility and  mutual  workmen's  compensation  and   mutual  casualty 
insurance  companies  requiring  their  members  to  make  premium 
deposits  to  provide  for  losses  and  expenses  shall  not  return  as 
income   any   portion   of   the   premium   deposits   returned    to   their 
policy-holders,    but    shall    return    as    taxable    income    all    income 
received  by  them  from  all  other  sources  plus   such  portions   of 
the    premium    deposits    as    are    retained    by    the    companies    for 
purposes    other   than    the    payment   of   losses    and    expenses    and 
reinsurance   reserves: 

207  Provided  further,  That  mutual  marine  insurance  companies  shall 
include  in  their  return  of  gross  income  gross  premiums  collected 
and   received    by   them   less   amounts   paid    for   reinsurance,    but 
shall    be    entitled    to    include    in    deductions    from    gross    income 
amounts    repaid    to    policy-holders    on    account   of   premiums    pre- 
viously   paid    by    them,    and    interest    paid    upon    such    amounts 
between  the  ascertainment  thereof  and  the  payment  thereof, 

208  and  life  insurance  companies  shall  not  include  as  income  in  any 
year    such    portion    of    any    actual    premium    received    from    any 
individual  policy-holder  as  shall  have  been  paid  back  or  credited 
to   such  individual  policy-holder,   or   treated   as   an   abatement  of 
premium  of  such  individual  policy-holder,  within  such  year; 

':09  Third.  The  amount  of  interest  paid  within  the  year  on  its  indebted- 

ness (except  on  indebtedness  incurred  for  the  purchase  of  obligations  or 
securities  the  interest  upon  which  is  exempt  from  taxation  as  income  un- 
der this  title)  to  an  amount  of  such  indebtedness  not  in  excess  of  the  pro- 
portion of  the  sum  of  (a)  the  entire  amount  of  the  paid-up  capital  stock 
outstanding  at  the  close  of  the  year,  or,  if  no  capital  stock,  the  entire 
amount  of  the  capital  employed  in  the  business  at  the  close  of  the  year, 
and  (b)  one-half  of  its  interest-bearing  indebtedness  then  outstanding, 


APPENDIX— TEXT    OF    LA\Y  15 

which  the  gross  amount  of  its  income  for  the  year  from  business  transact- 
ed and  capital  invested  within  the  United  States  bears  to  the  gross  amount 
of  its  income  derived  from  all  sources  within  and  without  the  United 
States: 

210  Provided,  That  in  the  case  of  bonds    or    other    indebtedness  which    have 
been  issued  with  a  guaranty  that    the    interest    payable  thereon  shall  be 
free  from  taxation,  no  deduction  for  the  payment   of   the    tax   herein  im- 
posed or  any  other  tax  paid  pursuant  to  such  guaranty  shall  be  allowed; 

211  and  in  case  of  a    bank,  banking    association,    loan    or   trust    company,  or 
branch  thereof,  interest  paid  within  the  year  on  deposits  by  or  on  moneys 
received  for  investment  from  either  citizens  or    residents  of    the    United 
States  and  secured  by  interest-bearing  certificates  of  indebtedness  issued 
by    such    bank,    banking    association,    loan    or    trust    company,  or  branch 
thereof; 

212  Fourth.    Taxes  paid  within  the  year  imposed  by  the  authority  of   the 
United  States   (except  income  and  excess  profits  taxes),  or    of    its  Terri- 
tories, or  possessions,  or    by  the  authority    of    any    State,  county,  school 
district,  or  municipality,  or  other  taxing    subdivision    of   any    State,  paid 
within  the  United  States,  not  including  those  assessed  against  local  bene- 
fits. 

213  (c)     In  the  case  of  assessment  insurance  companies,  whether  domes- 
tic or  foreign,  the  actual  deposit  of  sums  with  State  or  Territorial  officers, 
pursuant  to   law,   as   additions   to   guarantee   or   reserve   funds    shall   be 
treated  as  being  payments  required  by  law  to  reserve  funds. 

Returns 

214  Sec.    13.     (a)     The  tax  shall  be  computed  upon  the  net  income,  as 
thus  ascertained,   received   within  each  preceding  calendar  year  ending 
December  thirty-first: 

215  Provided,  That  any  corporation,  joint-stock  company  or  associa- 
tion, or  insurance  company,  subject  to  this  tax,  may  designate  the 
last  day  of  any  month  in  the  year  as  the  day  of  the  closing  of  its 
fiscal  year  and  shall  be  entitled  to  have  the  tax  payable  by  it 
computed  upon  the  basis  of  the  net  income  ascertained  as  herein 
provided  for  the  year  ending  on  the  day  so  designated  in  the  year 
preceding  the  date  of  assessment  instead  of  upon  the  basis  of  the 
net  income  for  the  calendar  year  preceding  the  date  of  assess- 
ment; 

216  and  it  shall  give  notice  of  the  day  it  has  thus  designated  as  the 
closing  of  its  fiscal  year  to  the  collector  of  the  district  in  which 
its  principal  business  office  is  located  at  any  time  not  less  than 
thirty    days    prior    to    the    first    day    of    March    of    the    year    in 
which  its  return  would  be  filed  if  made  upon  the  basis  of  the 
calendar  year; 

217  (b)     Every  corporation,  joint-stock  company  or  association,  or  insur- 
ance company,  subject   to   the    tax   herein    imposed,    shall,   on   or   before 
the  first  day  of  March,  nineteen  hundred  and  seventeen,  and  the  first  day 
of  March  in  each  year  thereafter,  or,  if  it  has  designated  a  fiscal  year 
for  the  computation  of  its  tax,  then  within  sixty  days  after  the  close  of 
such  fiscal  year  ending  prior  to  December  thirty-first,  nineteen  hundred 
and  sixteen,  and  the  close  of  each  such  fiscal  year  thereafter, 

218  render  a  true  and  accurate  return  of  its  annual  net  income  in  the  man- 
ner and  form  to  be  prescribed  by  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  and  containing  such 
facts,  data,  and  information  as  are  appropriate  and  in  the  opinion  of  the 
commissioner  necessary  to  determine  the  correctness  of  the  net  income 
returned  and  to  carry  out  the  provisions  of  this  title. 

219  The  return  shall  be  sworn  to  by  the  president,  vice-president,  or  other 
principal  officer,  and  by  the  treasurer  or  assistant  treasurer. 

220  The  return  shall  be  made  to  the  collector  of  the  district  in  which  is 
located  the  principal,  office  of  the  corporation,  company,  or  association, 
where  are  kept  its  books  of  account  and  other  data  from  which  the 
return  is  prepared, 


16  APPENDIX— TEXT    OF    LAW 

221  or  in  the  case  of  a  foreign  corporation,  company,  or  association,  to  the 
collector  of  the  district  in  which  is  located  its  principal  place  of  business 
in  the  United  States, 

222  or  if  it  have  no  principal  place  of  business,  office,  or  agency  in  the  United 
States,  then  to  the  collector  of  internal  revenue  at  Baltimore,  Maryland. 

223  All  such  returns  shall  as  received  be  transmitted   forthwith  by   the   col- 
lector to  the  Commissioner  of  Internal  Revenue; 

224  (c)     In  cases  wherein  receivers,  trustees  in  bankruptcy,  or  assignees 
are  operating  the  property  or  business  of  corporations,  joint-stock  com- 
panies or  associations,  or  insurance  companies,  subject  to  tax  imposed  by 
this   title,   such  receivers,   trustees,   or  assignees   shall   make   returns   of 
net  income  as  and  for  such  corporations,  joint-stock  companies  or  asso- 
ciations, and  insurance  companies,  in  the  same  manner  and  form  as  such 
organizations  are  hereinbefore  required  to  make  returns,  and  any  income 
tax  due  on  the   basis   of   such   returns   made   by   receivers,    trustees,   or 
assignees   shall   be   assessed   and    collected    in   the    same   manner   as   if 
assessed  directly  against  the  organizations  of  whose  businesses  or  prop- 
erties they  have  custody  and  control; 

225  (d)     A  corporation,  joint-stock  company  or  association,  or  insurance 
company,  keeping  accounts  upon  any  basis  other  than  that  of  actual  re- 
ceipts and  disbursements,  unless  such  other  basis  does  not  clearly  reflect 
its   income,  may,   subject  to  regulations   made   by  the   Commissioner  of 
Internal  Revenue,  with  the  approval  of  the   Secretary  of  the  Treasury, 
make  its  return  upon  the  basis  upon  which  its  accounts  are  kept,  in  which 
case  the  tax  shall  be  computed  upon  its  income  as  so  returned; 

226  (e)  All  the  provisions  of  this  title  relating  to  the  tax  authorized  and 
required  to  be  deducted  and  withheld  and  paid  to  the  officer  of  the  United 
States  Government  authorized  to  receive    the    same  from    the    income  of 
nonresident  alien  individuals  from  sources  within  the  United  States  shall 
be  made  applicable  to  the  tax  imposed  by  subdivision  (a)  of  section  ten 
upon  incomes  derived  from  interest  upon  bonds  and  mortgages  or  deeds  of 
trust  or  similar  obligations  of  domestic    or    other    resident  corporations, 
joint-stock  companies  or  associations,  and  insurance  companies  by  non- 
resident alien  firms,  copartnerships,  companies,  corporations,  joint-stock 
companies  or  associations,  and  insurance  companies,  not  engaged  in  busi- 
ness or  trade  within  the  United  States  and  not  having  any  office  or  place 
of  business  therein. 

227  (f )    Likewise,  all  the  provisions  of  this  title  relating  to  the  tax  author- 
ized and  required  to  be  deducted  and  withheld  and  paid  to  the  officer  of 
the  United  States  Government  authorized    to    receive  the  same  from  the 
income  of  nonresident  alien  individuals  from  sources  within  the  United 
States  shall  be  made  applicable    to    income  derived  from  dividends  upon 
the  capital  stock  or  from  net  earnings  of  domestic  or  other  resident  cor- 
porations, joint-stock  companies  or  associations,  and  insurance  companies, 
by  nonresident    alien    companies,    corporations,    joint-stock  companies  or 
associations,  and  insurance  companies  not  engaged  in  business  or  trade 
within  the  United  States  and  not  having  any  office  or  place    of   business 
therein. 

Assessment   and    Administration 

228  Sec.  14.     (a)     All  assessments  shall  be  made  and  the  several  corpo- 
rations, joint-stock  companies  or  associations,  and  insurance  companies 
shall  be  notified  of  the  amount  for  which  they  are  respectively  liable  on 
or  before  the  first  day  of  June  of  each  successive  year,  and  said  assess- 
ment shall  be  paid  on  or  before  the  fifteenth  day  of  June: 

229  Provided,   That  every  corporation,  joint-stock  company  or  asso- 
ciation, and  insurance  company,  computing  taxes  upon  the  income 
of  the  fiscal  year  which  it  may  designate  in  the  manner  herein- 
before provided,   shall  pay  the  taxes   due  under  its  assessment 
within  one  hundred  and  five  days  after  the  date  upon  which  it  is 
required  to  file  its  list  or  return  of  income  for  assessment; 

230  except  in,  cases  of  refusal  or  neglect  to  make  such  return,  and  in  cases 
of  erroneous,  false,  or  fraudulent  returns,  in  which  cases   the  Commis- 
sioner of  Internal  Revenue  shall,  upon  the  discovery  thereof,  at  any  time 


APPENDIX— TEXT    OF    LAW  17 

within  three  years  after  said  return  is  due,  make  a  return  upon  informa- 
tion obtained  as  provided  for  in  this  title  or  by  existing  law;  and  the 
assessment  made  by  the  Commissioner  of  Internal  Revenue  thereon  shall 
be  paid  by  such  corporation,  joint-stock  company  or  association,  or  insur- 
ance company  immediately  upon  notification  of  the  amount  of  such 
assessment; 

231  and  to  any  sum  or  sums  due  and  unpaid  after  the  fifteenth  day  of  June  in 
any  year,  or  after  one  hundred  and  five  days  from  the  date  on  which  the 
return  of  income  is  required  to  be  made  by  the  taxpayer,  and  after  ten 
days'  notice  and  demand  thereof  by  the  collector,  there  shall  be  added 
the  sum  of  five  per  centum  on  the  amount  of  tax  unpaid  and  interest  at 
the  rate  of  one  per  centum  per  month  upon  said  tax  from  the  time  the 
same  becomes  due: 

232  Provided,   That  upon  the   examination  of  any  return  of  income 
made   pursuant   to   this   title,   the   act   of  August   fifth,   nineteen 
hundred  and  nine,  entitled  "An  act  to  provide  revenue,  equalize 
duties  and  encourage  the  industries  of  the  United  States,  and  for 
other  purposes,"  and  the  act  of  October  third,  nineteen  hundred 
and  thirteen,  entitled,  "An  act  to  reduce  tariff  duties  and  to  pro- 
vide revenue  for  the  Government,  and  for  other  purposes,"  if  it 
shall  appear  that  amounts  of  tax  have  been  paid   in  excess  of 
those  properly  due,  the  taxpayer  shall  be  permitted  to  present  a 
claim  for  refund  thereof  notwithstanding  the  provisions  of  section 
thirty-two  hundred  and  twenty-eight  of  the  Revised  Statutes; 

233  (b)     When  the  assessment  shall  be  made,  as  provided  in  this  title, 
the  returns,  together  with  any  corrections  thereof  which  may  have  been 
made  by  the  commissioner,  shall  be  filed  in  the  office  of  the   Commis- 
sioner of  Internal   Revenue  and   shall  constitute   public  records   and   be 
"open  to  inspection  as  such: 

234  Provided,  That  any  and  all  such  returns  shall  be  open  to  inspec- 
tion only  upon  the  order  of  the  President,  under  rules  and  regula- 
tions   to   be   prescribed   by   the    Secretary   of   the   Treasury    and 
approved  by  the  President: 

235  Provided  further,  That  the  proper  officers  of  any  State  imposing 
a   general   income   tax   may,   upon   the    request   of   the   governor 
thereof,  have  access   to  said   returns  or  to  an  abstract  thereof, 
showing  the  name  and  income  of  each  such  corporation,  joint- 
stock    company   or    association,    or   insurance    company,    at    such 
times  and  in  such  manner  as  the  Secretary  of  the  Treasury  may 
prescribe; 

236  (c)     If  any  of  the  corporations,  joint-stock  companies  or  associations, 
or    insurance    companies    aforesaid    shall    refuse    o'r   neglect    to    make    a 
return  at  the  time  or  times  hereinbefore  specified  in  each  year,  or  shall 
render  a  false  or  fraudulent  return,  such  corporation,  joint-stock  company 
or  association,  or  insurance  company  shall  be  liable  to  a  penalty  of  not 
exceeding  $10,000: 

237  Provided,  That  the  Commissioner  of  Internal  Revenue  shall  have 
authority,   in   the   case   of  either  corporations   or  individuals    to 
grant  a  reasonable  extension  of  time  in  meritorious  cases,  as  he 
may  deem  proper. 

238  (d)     That    section    thirty-two    hundred    and    twenty-five    o"    the    Re- 
vised Statutes  of  the  United  States  be,  and  the  same  is  hereby,  amended 
so  as  to  read  as  follows: 

239  "Sec.  3225.     When  a  second  assessment  is  made  in  case  of  any  list, 
statement,  or  return,  which  in  the  opinion  of  the  collector  or  deputy  col- 
lector was  false  or  fraudulent,  or  contained  any  understatement  or  under- 
valuation, no  tax  collected  under  such  assessment  shall  be  recovered  by 
any  suit  unless  it  is  proved  that  the  said  list,  statement,  or  return  was 
not    false    nor    fraudulent    and    did   not    contain    any   understatement   or 
undervaluation;  but  this  section  shall  not  apply  to  statements  or  returns 
made  or  to  be  made  in  good  faith  under  the  laws  of  the  United  States 
regarding  annual  depreciation  of  oil  or  gas  wells  and  mines." 


18  APPENDIX— TEXT    OF    LAW 

Part  III. — General  Administrative  Provisions 

240  Sec.  15.     That  the  word   "State"   or  "United   States"   when   used   in 
this   title   shall   be   construed   to   include   any   Territory,    the   District   of 
Columbia,  Porto  Rico,  and  the  Philippine  Islands,  when  such  construction 
is  necessary  to  carry  out  its  provisions. 

241  Sec.  16.     That    sections    thirty-one   hundred    and    sixty-seven,    thirty- 
one  hundred  and  seventy-two,  thirty-one  hundred  and  seventy-three,  and 
thirty-one    hundred    and    seventy-six    of    the    Revised    Statutes    of    the 
United  States  as  amended  are  hereby  amended  so  as  to  read  as  follows : 

242  "Sec.  3167.     It  shall  be  unlawful  for  any  collector,  deputy  collector, 
agent,  clerk,  or  other  officer  or  employee  of  the  United  States  to  divulge 
or  to  make  known  in  any  manner  whatever  not  provided  by  law  to  any 
person  the  operations,  style  of  work,  or  apparatus  of  any  manufacturer 
or  producer  visited  by  him  in  the  discharge  of  his  official  duties,  or  the 
amount  or   source   of  income,   profits,   losses,   expenditures,   or  any   par- 
ticular thereof,  set  forth  or  disclosed  in  any  income  return,  or  to  permit 
any  income  return  or  copy  thereof  or  any  book  containing  any  abstract 
or  particulars  thereof  to  be  seen  or  examined  by  any  person  except  as 
provided  by  law; 

243  and  it  shall  be  unlawful  for  any  person  to  print  or  publish  in  any  manner 
whatever  not  provided  by  law  any  income  return  or  any  part  thereof  or 
source  of  income,  profits,  losses,  or  expenditures  appearing  in  any  income 
return ; 

244  and  any  offense  against  the  foregoing  provision  shall  be  a  misdemeanor 
and  be  punished  by  a  fine    not    exceeding  $1,000  or  by  imprisonment  not 
exceeding  one  year,  or  both,  at  the  discretion  of  the  court; 

245  and  if  the  offender  be  an  officer  or  employee  of  the  United  States  he  shall 
be  dismissed  from  office  or  discharged  from  employment. 

246  "Sec.  3172.     Every    collector    shall,    from    time    to    time,    cause    his 
deputies  to  proceed  through  every  part  of  his  district  and  inquire  after 
and  concerning  all  persons  therein  who  are  liable  to  pay  any  internal- 
revenue  tax,  and  all  persons  owning  or  having  the  care  and  management 
of  any  objects  liable  to  pay  any  tax,  and  to  make  a  list  of  such  persons 
and  enumerate  said  objects. 

247  "Sec.  3173.     It  shall   be   the   duty   of  any  person,   partnership,   firm, 
association,  or  corporation,  made  liable  to  any  duty,  special  tax,  or  other 
tax  imposed  by  law,  when  not  otherwise  provided  for,   (1)   in  case  of  a 
special  tax,  on  or  before  the  thirty-first  day  of  July  in  each  year,  (2)   in 
case  of  income  tax  on  or  before  the  first  day  of  March  in  each  year,  or 
on  or  before  the  last  day  of  the  sixty-day  period  next  following  the  clos- 
ing date  of  the  fiscal  year  for  which  it  makes  a  return  of  its  income, 
and  (3)  in  other  cases  before  the  day  on  which  the  taxes  accrue,  to  make 
a  list  or  return,  verified  by  oath,  to  the  collector  or  a  deputy  collector 
of  the   district  where  located,  of  the  articles   or  objects,   including  the 
amount  of  annual  income  charged  with  a  duty  or  tax,  the  quantity  of 
goods,  wares,  and  merchandise,  made  or  sold  and   charged  with  a  tax, 
the  several  rates  and  aggregate  amount,  according  to  the  forms  and  regu- 
lations to  be  prescribed  by  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  for  which  such  person, 
partnership,  firm,  association,  or  corporation  is  liable: 

248  Provided,  That  if  any  person  liable  to  pay  any  duty  or  tax,  or 
owning,  possessing,  or  having  the  care  or  management  of  prop- 
erty, goods,  wares,  and  merchandise,  articles  or  objects  liable  to 
pay  any  duty,  tax,  or  license,  shall  fail  to  make  and  exhibit  a  list 
or  return  required  by  law,  but  shall  consent  to  disclose  the  par- 
ticulars of  any  and  all  the  property,  goods,  wares,  and  merchan- 
dise, articles,  and  objects  liable  to  pay  any  duty  or  tax,  or  any 
business  or  occupation  liable  to  pay  any  tax  as  aforesaid,  then, 
and  in  that  case,  it  shall  be  the  duty  of  the  collector  or  deputy 
collector   to   make   such   list   or   return,   which,    being   distinctly 
read,  consented  to,  and  signed  and  verified  by  oath  by  the  person 
so  owning,  possessing,  or  having  the  care    and    management    as 


APPENDIX— TEXT    OF    LAW  19 

aforesaid,  may  be  received  as  the  list  of  such  person: 

249  Provided  further,  That  in  case  no  annual  list  or  return  has  been 
rendered  by  such  person  to  the  collector  or  deputy  collector  as 
required  by  law,  and  the  person  shall  be  absent  from  his  or  her 
residence   or   place   of  business   at   the   time   the   collector  or  a 
deputy  collector  shall  call  for  the  annual  list  or  return,  it  shall  be 
the  duty  of  such  collector  or  deputy  collector  to  leave  at  such 
place  of  residence  or  business,  with  some  one  of  suitable  age 
and   discretion,   if  such  be  present,  otherwise  to  deposit  in  the 
nearest  post  office,  a  note  or  memorandum  addressed  to  such  per- 
son, requiring  him  or  her  to  render  to  such  collector  or  deputy 
collector  the  list  or  return  required  by  law  within  ten  days  from 
the  date  of  such  note  or  memorandum,  verified  by  oath. 

250  And  if  any  person,  on  being  notified  or  required  as  aforesaid,  shall  refuse 
or  neglect  to  render  such  list  or  return  within  the  time  required  as  afore- 
said, or  whenever  any  person  who  is  required  to  deliver  a  monthly  or 
other  return  of  objects  subject  to  tax  fails  to  do  so  at  the  time  required, 
or  delivers  any  return  which,  in  the  opinion  of  the  collector,  is  erroneous, 
false,  or  fraudulent,  or  contains  any  undervaluation  or  understatement, 
or  refuses  to  allow  any  regularly  authorized  Government  officer  to  examine 
tie  books  of  such  person,  firm,  or  corporation,  it  shall  be  lawful  for  the 
collector  to  summon  such  person,  or  any  other  person  having  possession, 
custody,  or  care  of  books  of  account  containing  entries  relating  to  the 
business  of  such  person,  or  any  other  person  he  may  deem  proper,  to 
appear  before  him  and  produce  such  books  at  a  time  and  place  named  in 
the   summons,   and   to   give   testimony   or  answer   interrogatories,   under 
oath,  respecting  any  objects  or  income  liable  to  tax  or  the  returns  thereof. 

251  The  collector  may  summon  any  person  residing  or  found  within  the  State 
or  Territory  in -which  his  district  lies;  and  when  the  person  intended  to 
be  summoned  does  not  reside  and  can  not  be  found  within  such  State  or 
Territory,  he  may  enter  any  collection  district  where  such  person  may  be 
found  and  there  make  the  examination  herein  authorized.     And  to  this 
end   he  may  there   exercise  all   the  authority   which  he  might  lawfully 
exercise  in  the  district  for  which  he  was  commissioned: 

252  Provided,  That  'person,'  as  used  in  this  section,  shall  be  construed 
to   include   any   corporation,   joint-stock   company  or  association, 
or   insurance   company  when   such   construction   is   necessary  to 
carry  out  its  provisions. 

253  "Sec.  3176.     If  any  person,  corporation,  company,  or  association  fails 
to  make  and  file  a  return  or  list  at  the  time  prescribed  by  law,  or  makes, 
willfully  or  otherwise,  a  false  or  fraudulent  return  or  list,  the  collector 
or  deputy  collector  shall  make  the  return  or  list  from  his  own  knowledge 
and  from  such  information  as  he  can  obtain  through  testimony  or  other- 
wise. 

254  Any  return  or  list  so  made  and  subscribed  by  a  collector  or  deputy  col- 
lector shall  be  prima  facie  good  and  sufficient  for  all  legal  purposes. 

255  "If  the  failure  to  file  a  return  or  list  is  due  to  sickness  or  absence  the 
collector  may   allow   such   further   time,   not  exceeding   thirty  days,   for 
making  and  filing  the  return  or  list  as  he  deems  proper. 

256  "The  Commissioner  of  Internal  Revenue  shall  assess  all  taxes,  other 
than  stamp  taxes,  as  to  which  returns  or  lists  are  so  made  by  a  collector 
or  deputy  collector. 

257  In  case  of  any  failure  to  make  and  file  a  return  or  list  within  the  time 
prescribed   by  law   or   by   the   collector,    the    Commissioner   of   Internal 
Revenue  shall  add  to  the  tax  fifty  per  centum  of  its  amount 

258  except  that,  when  a  return  is  voluntarily  and  without  notice  from  the 
collector  filed  after  such  time  and  it  is  shown  that  the  failure  to  file  it 
was  due  to  a  reasonable  cause  and  not  to  willful  neglect,  no  such  addition 
shall  be  made  to  the  tax. 

259  In  case  a  false  or  fraudulent  return  or  list  is  willfully  made,  the  Com- 
missioner of  Internal  Revenue  shall  add  to  the  tax  one  hundred  per  centum 
of  its  amount. 


20  APPENDIX— TEXT    OF    LA\Y 

260  "The  amount  so  added   to  any  tax  shall  be   collected  at  the   same 
time  and  in  the  same  manner  and  as  part  of  the  tax  unless  the  tax  has 
been  paid  before  the  discovery  of  the  neglect,  falsity,  or  fraud,  in  which 
case  the  amount  so  added  shall  be  collected  in  the  same  manner  as  the 
tax." 

261  Sec.   17.     That   it  shall  be   the   duty   of   every   collector   of   internal 
revenue,   to  whom  any   payment  of  any  taxes   is   made   under   the   pro- 
visions of  this  title,  to  give  to  the  person  making  such  payment  a  full 
written    or    printed    receipt,    expressing    the    amount    paid    and    the    par- 
ticular account  for  which  such  payment  was  made; 

262  and  whenever  such  payment  is   made   such   collector   shall,   if  required, 
give  a  separate  receipt  for  each  tax  paid  by  any  debtor,  on  account  of 
payments  made  to  or  to  be  made  by  him  to  separate  creditors  in  such 
form   that   such   debtor    can    conveniently   produce   the    same    separately 
to  his  several  creditors  in  satisfaction  of  their  respective  demands  to  the 
amounts  specified  in  such  receipts; 

263  and  such  receipts  shall  be  sufficient  evidence  in  favor  of  such  debtor  to 
justify  him  in  withholding  the  amount  therein  expressed  from  his  next 
payment  to  his  creditors; 

264  but  such  creditor  may,  upon  giving  to  his  debtor  a  full  written  receipt, 
acknowledging  the  payment   to  him   of  whatever  sum  may   be   actually 
paid,  and  accepting  the  amount  of  tax  paid  as  aforesaid   (specifying  the 
same)   as  a  further  satisfaction  of  the  debt  to  that  amount,  require  the 
surrender  to  him  of  such  collector's  receipt. 

265  Sec.  18.  That  any  person,  corporation,  partnership,  association,  or  in- 
surance company,  liable  to  pay  the  tax,  to  make  a  return  or  to  supply  in- 
formation required  under  this  title,  who  refuses  or  neglects  to  pay  such 
tax,  to  make  such  return  or  to  supply  such  information    at    the    time    or 
times  herein  specified  in  each  year,  shall  be  liable, 'except  as  otherwise 
specially  provided  in  this  title,  to  a  penalty  of  not  less  than  $20  nor  more 
than  $1,000. 

266  Any  individual  or  any  officer  of  any  corporation,  partnership,  associa- 
tion, or  insurance  company,  required  by  law  to  make,  render,  sign,  or  veri- 
fy any  return  or  to  supply  any  information,  who  makes  any  false  or  fraud- 
ulent return  or  statement  with  intent  to  defeat  or  evade  the  assessment 
required  by  this  title  to  be  made,  shall  be  guilty  of  a  misdemeanor,  and 
shall  be  fined  not  exceeding  $2,000   or   be    imprisoned    not   exceeding  one 
year,  or  both,  in  the  discretion  of  the  court,  with  the  costs  of  prosecution: 

267  Provided,  That  where  any  tax  heretofore  due  and  payable  has  been 
duly  paid  by  the  taxpayer,  it  shall  not  be  re-collected  from  any  withhold- 
ing agent  required  to  retain  it  at  its  source,  nor  shall  any  penalty  be  im- 
posed or  collected  in  such  cases  from  the  taxpayer,  or  such  withholding 
agent  whose  duty  it  was  to  retain  it,  for  failure  to  return  or  pay  the  same, 
unless  such  failure  was  fraudulent  and  for    the    purpose  of    evading  pay- 
ment. 

268  Sec.  19.     The  collector  or  deputy  collector  shall  require  every  return 
to  be  verified  by  the  oath  of  the  party  rendering  it.     If  the  collector  or 
deputy  collector  have  reason  to  believe  that  the  amount  of  any  income 
returned  is  understated,  he  shall  give  due  notice  to  the  person  making 
the  return  to  show  cause  why  the  amount  of  the  return  should  not  be 
increased,  and  upon  proof  of  the  amount  understated  may  increase  the 
same  accordingly. 

269  Such  person  may  furnish   sworn  testimony  to   prove  any  relevant  facts, 
and,  if  dissatisfied  with  the  decision  of  the  collector,  may  appeal  to  the 
Commissioner  of  Internal  Revenue  for  his  decision  under  such  rules  of 
procedure  as  may  be  prescribed  by  regulation. 

270  Sec.  20.     That    jurisdiction    is    hereby    conferred    upon    the    district 
courts   of  the   United    States   for   the   district   within   which   any   person 
summoned  under  this  title  to  appear  to  testify  or  to  produce  books  shall 
reside,  to  compel  such  attendance,  production  of  books,  and  testimony  by 
appropriate  process. 


APPENDIX— TEXT    OF    LAW  21 

271  Sec.  21.     That  the  preparation  and  publication  of  statistics  reasonably 
available  with  respect  to  the  operation  of  the  income  tax  law  and  contain- 
ing classifications  of  taxpayers  and  of  income,  the  amounts  allowed  as 
deductions  and   exemptions,  and  any  other  facts   deemed   pertinent  and 
valuable,  shall  be  made  annually  by  the  Commissioner  of  Internal  Revenue 
with  the  approval  of  the  Secretary  of  the  Treasury. 

272  Sec.  22.     That  all  administrative,  special,  and  general  provisions  of 
law.  including  the  laws  in  relation  to  the  assessment,  remission,  collection, 
and  refund  of  internal-revenue  taxes  not  heretofore  specifically  repealed 
and  not  inconsistent  with  the  provisions  of  this  title,  are  hereby  extended 
and   made   applicable   to   all   the  provisions   of  this   title   and   to   the   tax 
herein  imposed. 

273  Sec.  23.     That  the  provisions  of  this  title  shall  extend  to  Porto  Rico 
and  the  Philippine  Islands. 

274  Provided,  That  the  administration  of  the  law  and  the  collection 
of  the   taxes   imposed   in   Porto   Rico  and   the   Philippine   Islands 
shall  be  by  the  appropriate  internal-revenue  officers  of  those  gov- 
ernments,   and    all    revenues    collected    in    Porto    Rico    and    the 
Philippine  Islands,  thereunder  shall  accrue  intact  to  the  general 
governments   thereof,    respectively: 

275  Provided  further,  That  the  jurisdiction  in  this  title  conferred  upon 
the  district  courts  of  the  United  States  shall,  so  far  as  the  Philip- 
pine Islands  are  concerned,  be  vested  in  the  courts  of  the  first 
instance  of  said  islands: 

276  And  provided  further,  That  nothing  in  this  title  shall  be  held  to 
exclude   from   the    computation   of   the   net   income   the   compen- 
sation  paid   any  official  by   the   governments   of  the   District  of 
Columbia,  Porto  Rico,  and  the  Philippine  Islands,  or  the  political 
sub-divisions  thereof. 

277  Sec.  24.     That  Section  II  of  the  Act  approved  October  third,  nineteen 
hundred  and  thirteen,  entitled  "An  Act  to  reduce  tariff  duties  and  to  pro- 
vide revenue   for   the   Government,   and   for   other  purposes,"   is   hereby 
repealed,  except  as  herein  otherwise  provided,  and  except  that  it  shall 
remain  in  force  for  the  assessment  and  collection  of  all  taxes  which  have 
accrued  thereunder,  and  for  the  imposition  and  collection  of  all  penalties 
or  forfeitures  which  have  accrued  or  may  accrue  in  relation  to  any  of  such 
taxes,  and  except  that  the  unexpended  balance  of  any  appropriation  here- 
tofore made  and  'now  available  for  the  administration  of  such  section  or 
any  provision   thereof   shall   be   available   for   the   administration   of   this 
title  or  the  corresponding  provision  thereof. 

278  Sec.  25.     That  income  on  which  has  been  assessed  the  tax  imposed 
by  Section  II  of  the  Act  entitled  "An  Act  to  reduce  tariff  duties  and  to 
provide  revenue  for  the  Government,  and  for  other  purposes,"  approved 
October  third,  nineteen  hundred  and  thirteen,  shall  not  be  considered  as 
income  within  the  meaning  of  this  title: 

279  Sec.  26.  Every  corporation,  joint-stock  company  or  association,  or  in- 
surance company  subject  to  the  tax  herein  imposed,  when  required  by  the 
Commissioner  of  Internal  Revenue, 

280  shall  render  a  correct  return,  duly  verified  under  oath,    of    its    payments 
of  dividends,  whether  made  in  cash  or  its  equivalent  or  in  stock, 

281  including  the  names  and  addresses  of  stockholders    and    the    number    of 
shares  owned  by  each, 

282  and  the  tax  years  and  the  applicable  amounts    in    which    such    dividends 
were  earned, 

283  in  such  form    and  manner    as  may  be  prescribed    by    the    Commissioner 
of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury. 

284  Sec.  27.  That  every  person,   corporation,  partnership,  or  association, 
doing  business  as  a  broker  on  any  exchange  or  board    of    trade    or   other 
similar  place  of  business 

285  shall,    when    required    by    the    Commissioner    of    Internal    Revenue,  ren- 
der a  correct  return  duly  verified  under  oath,  under  such  rules  and  regu- 


22  APPENDIX— TEXT    OF    LAW 

lationB  as  the  Commissioner  of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  may  prescribe, 

286  showing  the  names  of  customers  for  whom  such  person,  corporation,  part- 
nership, or  association  has  transacted  any  business, 

287  with  such  details  as  to  the  profits,  losses,  or  other  information  which  the 
commissioner  may  require,  as  to  each  of  such  customers, 

288  as    will    enable    the    Commissioner    of   Internal     Revenue     to     determine 
whether  all  income  tax  due  on  profits  or  gains  of  such  customers  has  been 
paid. 

289  Sec.  28.  That  all  persons,  corporations,  partnerships,  associations,  and 
insurance  companies,  in  whatever  capacity  acting,  including 

290  lessees  or  mortgagors  of  real  or  personal  property, 

291  trustees  acting  in  any  trust  capacity, 

292  executors,  administrators,  receivers,  conservators, 

293  and  employers, 

294  making  payment  to  another  person,  corporation,  partnership,  association, 
or  insurance  company, 

295  of  interest,  rent,  salaries,  wages,  premiums,  annuities,  compensation,  re- 
muneration, emoluments,  or  other  fixed  or  determinable  gains,  profits,  and 
income  (other  than  payments  described  in  sections  twenty-six  and  twenty- 
seven), 

296  of  $800  or  more  in  any  taxable  year, 

297  or,  in  the  case  of  such  payments  made  by  the  United  States,  the  officers 
or  employees  of  the  United  States  having  information  as  to  such  payments 
and  required  to  make  returns  in  regard  thereto  by  the  regulations  herein- 
after provided  for, 

298  are  hereby  authorized  and  required  to  render  a  true  and  accurate  return 
to  the  Commissioner  of  Internal  Revenue,  under  such  rules    and    regula- 
tions and  in  such  form  and  manner  as  may  be  prescribed  by  him,  with  the 
approval  of  the  Secretary  of  the  Treasury, 

299  setting  forth  the  amount  of  such  gains,  profits,  and  income, 

300  and  the  name  and  address  of  the  recipient  of  such  payment: 

301  Provided,  That  such  returns  shall  be  required,  regardless  of  amounts,  in 
the  case  of  payments  of  interest  upon  bonds  and  mortgages  or  deeds  of 
trust  or  other  similar  obligations  of  corporations,  joint-stock  companies, 
associations,  and  insurance  companies,  and  in  the  case   of   collections  of 
items  (not  payable  in  the   United    States)    of   interest  upon  the  bonds  of 
foreign  countries   and    interest  from   the   bonds   and    dividends  from  the 
stock  of  foreign  corporations  by  persons,  corporations,  partnerships,  or 
associations,  undertaking  as  a  matter  of  business  or  for  profit  the  collec- 
tion of  foreign  payments  of  such  interest  or  dividends  by  means  of  cou- 
pons, checks,  or  bills  of  exchange. 

802  When  necessary  to  make  effective  the  provisions  of  this  section  the 

name  and  address  of  the  recipient  of  income  shall  be  furnished  upon  de- 
mand of  the  person,  corporation,  partnership,  association,  or  insurance 
company  paying  the  income. 

303  The  provisions  of  this  section  shall  apply  to  the  calendar  year  nine- 
teen hundred  and  seventeen  and  each  calendar  year  thereafter,    but  shall 
not  apply  to  the  payment  of  interest  on  obligations  of  the  United  States. 

304  Sec.     29.  That  in  assessing  income  tax  the   net    income  embraced  in 
the  return  shall  also  be  credited  with  the  amount  of  any  excess  profits  tax 
imposed  by  Act  of  Congress  and  assessed  for  the  same  calendar  or  fiscal 
year  upon  the  taxpayer  and,  in  the   case   of   a   member  of  a  partnership, 
with  his  proportionate  share  of  such  excess  profits  tax  imposed  upon  the 
partnership. 

305  Sec.  30.  That  nothing  in  section  II  of  the  Act  approved  October  third, 
nineteen  hundred  and  thirteen,  entitled  'An  Act  to  reduce  tariff  duties  and 
to  provide  revenue  for  the  Government,  and  for  other  purposes,'  or  in  this 
title,  shall  be  construed  as  taxing  the  income  of  foreign  governments  re- 
ceived from  investments  in  the  United  States  in  stocks,  bonds,  or  other 
domestic  securities,  owned  by  such  foreign  governments,  or  from  interest 


APPENDIX— TEXT    OF    LAW  23 

on  deposits  in  banks  in  the  United  States  of  moneys  belonging  to  foreign 
governments. 

306  Sec.  31.   (a)   That  the  term  'dividends'  as  used  in  this  title  shall  be 
held  to  mean  any  distribution  made  or  ordered  to  be  made  by  a  corpora- 
tion, joint-stock  company,  association,    or    insurance    company,  out  of  its 
earnings  or  profits  accrued  since  March  first,  nineteen  hundred  and  thir- 
teen, and  payable  to  its  shareholders,  whether  in  cash  or  in  stock  of  the 
corporation,    joint-stock    company,    association,    or    insurance    company, 
which  stock  dividend  shall  be  considered  income,    to    the   amount  of  the 
earnings  or  profits  so  distributed. 

307  (b)  Any  distribution  made  to  the  share-holders  or  members  of  a  cor- 
poration, joint-stock  company,  or  association,  or  insurance  company,  in  the 
year  nineteen  hundred  and  seventeen,  or  subsequent  tax  years,  shall  be 
deemed  to  have  been  made  from  the  most  recently  accumulated  undivided 
profits  or  surplus,  and  shall  constitute  a  part  of  the  annual  income  of  the 
distributee  for  the  year  in  which  received,  and  shall  be  taxed  to  the  distri- 
butee at  the  rates  prescribed  by  law  for  the  years  in  which  such  profits  or 
surplus  were  accumulated  by  the  corporation,  joint-stock  company,  asso- 
ciation, or  insurance  company, 

308  but  nothing  herein  shall  be  construed    as    taxing  any  earnings  or  profits 
accrued  prior  to  March  first,  nineteen  hundred  and  thirteen,  but  such  earn- 
ings or  profits  may  be  distributed  in  stock  dividends  or  otherwise,  exempt 
from  the  tax,  after  the  distribution  of  earnings  and  profits  accrued  since 
March  first,  nineteen  uimuied  and  thirteen,  has  been  made. 

309  This  subdivision  shall  not  apply  to  any  distribution  made  prior  to  August 
sixth,  nineteen  hundred  and  seventeen,  out  of  earnings  or  profits  accrued 
prior  to  March  first,  nineteen  hundred  and  thirteen. 

310  Sec.  32.  That  premiums  paid  on  life  insurance  policies  covering  the 
lives  of  officers,  employees,  or  those  financially  interested  in  any  trade  or 
business  conducted  by  an  individual,  partnership,  corporation,  joint-stock 
company  or  association,  or  insurance  company,  shall  not  be  deducted  in 
computing  the  net  income  of  such  individual,  corporation,  joint-stock  com- 
pany or  association,  or  insurance  company,  or  in  computing  the  profits  of 
such  partnership  for  the  purposes  of  subdivision  (e)  of  section  nine. 

311  That  any  amount  heretofore  withheld    by    any    withholding  agent  as 
required  by  Title  I  of  such  Act  of  September  eighth,  nineteen  hundred  and 
sixteen,  on  account  of  the  tax  imposed  upon  the  income  of  any  individual, 
a  citizen  or  resident  of  the  United  States,  for  the  calendar  year  nineteen 
hundred  and  seventeen,  except  in  the  cases  covered  by  subdivision  (c)  of 
section  nine  of  such  Act,  as  amended  by  this    Act,    shall  be  released  and 
paid  over  to  such  individual,  and  the  entire  tax  upon  the  income  of  such 
individual  for  such    year    shall    be    assessed  and  collected  in  the  manner 
prescribed  by  such  Act  as  amended  by  this  Act. 


THE  WAR  INCOME  TAX. 


Title  I  of  the 
Act  of  October  3,  1917. 


(The  taxes  imposed  by  this  Title  are  in  addition  to  those  imposed 
by  the  Act  of  September  8,  1916,  as  amended  by  other  provisions  of 
the  Act  of  October  3,  1917.) 


1  Section  1.     That  during  the  present  war 

2  in  addition  to  the  normal  tax  imposed  by  subdivision  (a)  of  section  one  of 
the  Act  entitled  "An  Act  to  increase  the  revenue,  and  for  other  purposes." 


24  APPENDIX— TEXT    OF    LAW 

approved  September  eighth,  nineteen  hundred  and  sixteen, 

3  there  shall  be  levied,  assessed,  collected,  and  paid 

4  a  like  normal  tax  of  two  per  centum  upon  the  income  of  every 

5  individual,  a  citizen  or  resident  of  the  United  States, 

6  received  in  the  calendar  year  nineteen  hundred  and  seventeen  and  every 
calendar  year  thereafter. 

7  Sec.  2.  Tha,t  during  the  present  war 

8  in  addition  to  the  additional  tax  imposed  by  subdivision  (b)  of  section  one 
of  such  Act  of  September  eighth,  nineteen  hundred  and  sixteen, 

9  there  shall  be  levied,  assessed,  collected,  and  paid 

10  a  like  additional  tax  upon  the  income  of 

11  every  individual  received  in  the  calendar  year  nineteen  hundred  and  sev- 
enteen and  every  calendar  year  thereafter,  as  follows: 

12  One  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $5,000  and  does  not  exceed  $7,500; 

13  Two  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $7,500  and  does  not  exceed  $10,000; 

14  Three  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $10,000  and  does  not  exceed  $12,500; 

15  Four  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $12,500  and  does  not  exceed  $15,000; 

16  Five  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $15,000  and  does  not  exceed  $20,000; 

17  Seven  per  centum  per  annum  upon  the    amount   by   which    the    total 
net  income  exceeds  $20,000  and  does  not  exceed  $40,000; 

18  Ten  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $40,000  and  does  not  exceed  $60,000; 

19  Fourteen  per  centum  per  annum  upon  the  amount  by  which  the  total 
net  income  exceeds  $60,000  and  does  not  exceed  $80,000; 

20  Eighteen  per  centum  per  annum  upon  the  amount  by  which  the  total 
net  income  exceeds  $80,000  and  does  not  exceed  $100,000; 

21  Twenty-two  per  centum    per   annum   upon    the    amount  by  which  the 
total  net  income  exceeds  $100,000  and  does  not  exceed  $150,000; 

22  Twenty-five  per  centum  per  annum  upon    the    amount   by    which    the 
total  net  income  exceeds  $150,000  and  does  not  exceed  $200,000; 

23  Thirty  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $200,000  and  does  not  exceed  $250,000; 

24  Thirty-four  per  centum  per  annum  upon  the  amount  by  which  the  total 
net  income  exceeds  $250,000  and  does  not  exceed  $300,000; 

25  Thirty-seven .  per  centum  per  annum  upon  the  amount    by    which  the 
total  net  income  exceeds  $300,000  and  does  not  exceed  $500,000; 

26  Forty  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $500,000  an  does  not  exceed  $750,000. 

27  Forty-five  per  centum  per  annum  upon  the  amount  by  which  the  total 
net  income  exceeds  $750,000  and  does  not  exceed  $1,000,000. 

28  Fifty  per  centum  per  annum  upon  the  amount  by  which  the  total  net 
income  exceeds  $1,000,000. 

29  Sec.  3.  That  the  taxes  imposed  by  sections  one  and  two  of   this    Act 
shall  be  computed,  levied,  assessed,  collected,    and    paid    upon    the  same 
basis  and  in  the  same  manner  as  the  similar  taxes  imposed  by  section  one 
of  such  Act  of  September  eighth,  nineteen  hundred  and  sixteen, 

30  except  that  in  the  case  of  the  tax  imposed  by  section  one  of  this  Act 

31  (a)  the  exemptions  of  $3,000  and  $4,000  provided  in  section  seven  of  such 
Act  of  September  eighth,  nineteen  hundred  and  sixteen,    as    amended  by 
this  Act,  shall  be,  respectively,  $1,000  and  $2,000,  and 

32  (b)  the  returns  required  under  subdivisions  (b)  and  (c)  of  section  eight  or 
such  Act,  as  amended  by  this  Act,  shall  be  require'd  in  the  case  of  net  in- 
comes of  $1,000  or  over,  in  the  case  of  unmarried  persons,  and    $2,000    or 
over  in  the  case  of  married  persons,  instead  of  $3,000  or  over;  as  therein 
provided,  and 

33  (c)    the  provisions   of   subdivision    (c)    of   section   nine   of  such  Act,   as 
amended  by  this  Act,  requiring  the  normal  tax  of  individuals  on  income 


APPENDIX— TEXT    OF    LAW  25 

derived  from  interest  to  be  deducted  and  withheld  at  the  source  of  the  in- 
come shall  not  apply  to  the  new  two  per  centum  normal  tax  prescribed  in 
section  one  of  this  Act  until  on  and  after  January  first,  nineteen  hundred 
and  eighteen,  and  thereafter  only  one  two  per  centum  normal  tax  shall  be 
deducted  and  withheld  at  the  source  under  the  provisions  of  such  subdivi- 
sion (c),  and  any  further  normal  tax  for  which  the  recipient  of  such  in- 
come is  liable  under  this  Act  or  such  Act  of  September  eighth,  nineteen 
hundred  and  sixteen,  as  amended  by  this  Act,  shall  be  paid  by  such  recip- 
ient. 

34  Sec.  4.  That  in  addition  to  the  tax  imposed  by  subdivision  (a)  of  sec- 
tion ten  of  such  Act  of  September  eighth,  nineteen  hundred  and  sixteen, 
as  amended  by  this  Act, 

35  there  shall  be  levied,  assessed,  collected,  and  paid 

36  a  like  tax  of  four  per  centum 

37  upon  the  income  received    in    the    calendar   year   nineteen    hundred    and 
seventeen  and  every  calendar  year  thereafter, 

38  by  every  corporation,  joint-stock  company    or    association,    or    insurance 
company,  subject  to  the  tax  imposed  by  that  subdivision  of  that  section, 

39  except  that  if  it  has  fixed  its  own   fiscal   year,    the   tax   imposed   by   this 
section    for   the    fiscal   year    ending   during    the    calendar   year   nineteen 
hundred  and  seventeen  shall  be  levied,  assessed,  collected,  and  paid  only 
on  that  proportion  of  its  income  for  such  fiscal  year  which  the  period  be- 
tween January  first,  nineteen  hundred  and  seventeen,  and  the  end  of  such 
fiscal  year  bears  to  the  whole  of  such  fiscal  year. 

40  The  tax  imposed  by  this  section  shall  be  computed,  levied,  assessed, 
collected,  and  paid  upon  the  same  incomes  and  in  the  same  manner  as  the 
tax  imposed  by  subdivision  (a)  of  section  ten  of   such  Act  of    September 
eighth,  nineteen  hundred  and  sixteen,  as  amended  by  this  Act, 

41  except  that  for  the  purpose  of  the  tax  imposed  by  this  section 

42  the  income  embraced  in  a  return  of  a  corporation,  joint-stock  company  or 
association,  or  insurance  company, 

43  shall  be  credited  with  the  amount  received  as  dividends  upon  the  stock  or 
from  the  net  earnings    of   any    other  corporation,  joint-stock  company  or 
association,  or  insurance  company,  which  is  taxable  upon  its  net  income 
as  provided  in  this  title. 

44  Sec.  5.  That  the  provisions  of  this  title  shall  not  extend  to  Porto  Rico  or 
the  Philippine  Islands,  and  the  Porto  Rican  or  Philippine  Legislature  shall 
have  power  by  due  enactment  to  amend,  alter,  modify,  or  repeal  the  in- 
come tax  laws  in  force  in  Porto  Rico   or   the   Philippine   Islands,    respec- 
tively. 


THE   EXCESS   PROFITS  TAX 


Title  II  of  the  Act  of  October  3,  1917. 


Sec.  200.  That  when  used  in  this  title — 

The    term    "corporation"  includes    joint-stock    companies    or   associations 
and  insurance  companies; 

The  term  "domestic"  means  created  under  the  law  of  the  United  States, 
or  of  any  state,  territory,  or  district  thereof, 

and  the  term  "foreign  means  created  under  the  law  of  any  other  posses- 
sion of  the  United  States  or  of  any  foreign  country  or  government; 
The  term  "United  States"  means  only  the  States,  the  Territories  of  Alas- 
ka and  Hawaii,  and  the  District  of  Columbia; 


26  APPENDIX— TEXT    OF    LAW 

5  The   term    "taxable   year"   means    the    twelve    months    ending   December 
thirty-first, 

6  excepting  in  the  case  of  a  corporation  or  partnership  which  has  fixed  its 
own  fiscal  year,  in  which  case  it  means  such  fiscal  year. 

7  The  first  taxable  year  shall  be  the  year  ending  December  thirty-first,  nine- 
teen hundred  and  seventeen, 

8  except  that  in  the  case  of  a  corporation  or  partnership  which  has  fixed  its 
own  fiscal  year,  it  shall  be  the  fiscal  year  ending  during  the  calendar  year 
nineteen  hundred  and  seventeen. 

9  If  a  corporation  or  partnership,  prior  to  March  first,  nineteen  hundred  and 
eighteen,  makes  a  return  covering"  its  own  fiscal  year,  and  includes  there- 
in the  income  received  during  that  part  of  the  fiscal  year  falling  within 
the  calendar  year  nineteen  hundred  and  sixteen,  the  tax  for  such  taxable 
year  shall  be  that  proportion  of  the  tax  computed   upon   the   net   income 
during  such  full  fiscal  year  which  the  time  from  January  first,  nineteen 
hundred  and  seventeen,    to    the    end  of  such  fiscal  year  bears  to  the  full 
fiscal  year;  and 

10  The  term  "prewar  period"  means  the  calendar  years  nineteen  hundred  and 
eleven,  nineteen  hundred  and  twelve,  and  nineteen  hundred  and  thirteen, 
or, 

11  if  a  corporation  or  partnership  was  not  in  existence  or 

12  an  individual  was  not  engaged  in  a  trade  or  business 

13  during  the  whole  of  such  period, 

14  then  as  many  of  such  years  during  the  whole  of  which  the  corporation  or 
partnership  was  in  existence  or  the  individual  was  engaged  in  the  trade 
or  business. 

15  The  terms  "trade"  and  "business"  include  professions    and    occupa- 
tions. 

16  The  term  "net  income"  means  in  the  case  of  a  foreign  corporation  or 
partnership  or  a  nonresident  alien  individual,    the    net    income    received 
from  sources  within  the  United  States. 

17  Sec.  201.  That  in  addition  to  the  taxes  under  existing  law  and  under 
this  Act  there  shall  be  levied,  assessed,  collected,  and  paid  for  each  tax- 
able year  upon  the  income  of  every  corporation,  partnership,  or  individual, 
a  tax  (hereinafter  in  this  title  referred  to  as  the  tax)  equal  to  the  follow- 
ing percentages  of  the  net  income: 

18  Twenty  per  centum  of  the  amount  of  the  net  income  in  excess  of  the 
deduction    (determined   as    hereinafter   provided)    and    not   in    excess    of 
fifteen  per  centum  of  the  invested  capital  for  the  taxable  year; 

19  Twenty-five  per  centum  of  the  amount  of  the  net  income  in  excess  of 
fifteen  per  centum  and  not  in  excess  of  twenty  per  centum  of  such  capital; 

20  Thirty-five  per  centum  of  the  amount  of  the  net  income  in  excess  of 
twenty  per  centum  and  not  in  excess  of  twenty-five  per  centum    of   such 
capital  ; 

21  Forty-five  per  centum  of  the  amount  of  the  net  income  in  excess  of 
twenty-five  per  centum  and  not  in  excess  of  thirty-three    per    centum  of 
such  capital;  and 

22  Sixty  per  centum  of  the  amount  of  the  net  income  in  excess  of  thirty- 
three  per  centum  of  such  capital. 

23  For  the  purpose    of    this    title    every    corporation  or  partnership  not 
exempt  under  the  provisions  of  this  section  shall  be  deemed  to  be  engaged 
in  business,  and 

24  all  the  trades  and  businesses  in  which  it  is  engaged  shall  be  treated  as  a 
single  trade  or  business,  and 

25  all  its  income  from  whatever  source  derived  shall   be    deemed    to   be   re- 
ceived from  such  trade  or  business. 

26  This  title  shall  apply  to  all  trades  or  businesses  of  whatever  descrip- 
tion, whether  continuously  carried  on  or  not,  except — 

27  (A)  In  the  case  of  officers  and  employees  under  the  United  States,  or 
any  State,  Territory,  or  the  District  of  Columbia,  or  any  local  subdivision 
thereof,  the  compensation  or  fees  received  by  them  as  such  officers  or  em- 
ployees ; 


APPENDIX— TEXT    OF    LAW  27 

28  (B)   Corporations  exempt  from  tax  under    the    provisions    of    section 
eleven  of  Title  I  of  such  Act  of  September  eighth,  nineteen  hundred  and 
sixteen,  as  amended  by  this  Act,  and  partnerships  arid  individuals  carry- 
ing on  or  doing  the  same  business,  or  coming  within  the  same  description; 
and 

29  (C)  Incomes  derived  from  the  business  of  life,  health,  and  accident 
insurance  combined  in  one  policy  issued  on  the  weekly  premium  payment 
plan. 

30  Sec.  202.  That  the  tax  shall  not  be  imposed  in  the  case  of  the  trade  or 
business  of  a  foreign  corporation  or  partnership  or  a  nonresident  alien  in- 
dividual, the  net  income  of  which  trade   or   business    during   the    taxable 
year  is  less  than  $3,000. 

31  Sec.  203.  That  for  the  purposes  of  this  title  the  deduction  shall  be  as 
follows,  except  as  otherwise  in  this  title  provided — 

32  (A)  In  the  case  of  a  domestic  corporation,  the  sum  of  (1)  an  amount 
equal  to  the  same  percentage  of  the  invested  capital  for  the  taxable  year 
which  the  average  amount  of  the  annual  net  income  of  the  trade  or  busi- 
ness during  the  prewar  period  was  of  the  invested  capital  for  the  prewar 
period  (but  not  less  than  seven  or  more  than  nine  per  centum  of  the  in- 
vested capital  for  the  taxable  year),  and  (2)  $3,000; 

33  (B)  In  the  case  of  a  domestic  partnership  or  of  a  citizen  or  resident 
of  the  United  States,  the  sum  of  (1)  an  amount  equal    to    the    same  per- 
centage of  the  invested  capital  for    the    taxable  year  which  the  average 
amount  of  the  annual  net  income  of  the  trade  or  business  during  the  pre- 
war period  was  of  the  invested  capital  for  the  prewar  period  (but  not  less 
than  seven  or  more  than  nine  per  centum  of  the  invested  capital  for  the 
taxable  year),  and  (2)  $6,000; 

34  (C)  In  the  case  of  a  foreign  corporation  or  partnership  or  of  a  non- 
resident alien  individual,  an  amount  ascertained  in  the  same  manner  as 
provided  in  subdivisions  (A)  and  (B),  without  any  exemption  of  $3,000  or 
$6,000. 

35  (D)  If  the  Secretary  of  the  Treasury  is  unable  satisfactorily    to    de- 
termine the  average  amount  of  the  annual  net  income  of  the  trade  or  busi- 
ness during  the  prewar  period,  the  deduction  shall  be  determined  in  the 
same  manner  as  provided  in  section  two  hundred  and  five. 

36  Sec.  204.  That  if  a  corporation  or  partnership  was  not  in  existence,  or 

37  an  individual  was  not  engaged  in  the  trade  or  business, 

38  during  the  whole  of  any  one  calendar  year  during  the  prewar  period, 

39  the  deduction  shall  be  an  amount  equal   to   eight   per   centum  of  the  in- 
vested capital  for  the  taxable  year,  plus 

40  in  the  case  of  a  domestic  corporation  $3,000,  and 

41  in  the  case  of  a  domestic  partnership  or  a  citizen  or  resident  of  the  United 
States  $6,000. 

42  A  trade    or   business  carried  on  by  a  corporation,  partnership,  or  in- 
dividual, although  formally  organized  or  reorganized  on  or  after  January 
second,  nineteen  hundred  and  thirteen,  which  is  substantially  a  continua- 
tion of  a  trade  or  business  carried  on  prior   to   that   date,   shall,  for  the 
purpose  of  this  title,  be  deemed  to  have  been  in  existence  prior  to  that 
date,  and  the  net  income  and  invested  capital  of  its  predecessor  prior  to 
that  date  shall  be  deemed    to   have   been   its   net   income   and    invested 
capital. 

43  Sec.  205.   (A)  That  if  the  Secretary  of    the    Treasury,  upon  complaint 
finds  either 

44  (1)  That  during  the  prewar  period  a  domestic  corporation  or  partnership, 
or 

45  a  citizen  or  resident  of  the  United  States, 

46  had  no  net  income  from  the  trade  or  business,  or 

47  (2)  That  during  the  prewar  period  the  percentage,  which  the  net  income 
was  of  the  invested  capital,  was  low   as    compared   with   the   percentage, 
which  the  net  income  during  such  period  of  representative  corporations, 


28  APPENDIX— TEXT    OF    LAW 

partnerships,  and  individuals,  engaged  in  a  like  or  similar  trade  or  busi- 
ness, was  of  their  invested  capital, 

48  then  the  deduction  shall  be  the  sum  of 

49  (1)  an  amount  equal  to  the  same  percentage    of    its    invested    capital    for 
the  taxable  year  which  the  average  deduction   (determined  in  the  same 
manner  as  provided  in  section  two  hundred  and  three,  without  including 
the  $3,000  or  $6,000  therein  referred  to)   for  such  year  of    representative 
corporations,  partnerships,   or    individuals,    engaged   in  a  like  or  similar 
trade  or  business,  is  of  their  average  invested  capital  for  such  year,  plus 

50  (2)   in  the  case  of  a  domestic  corporation    $3,000,  and    in    the    case    of    a 
domestic  partnership  or  a  citizen  or  resident  of  the  United  States  $6,000. 

51  The  percentage  which  the  net  income  was  of  the  invested  capital  in 
each  trade  or  business    shall    be    determined  by  the  commissioner  of  in- 
ternal revenue,  in  accordance  with  regulations  prescribed    by    him,    with 
the  approval  of  the  Secretary  of  the  Treasury. 

52  In  the  case  of  a  corporation  or  partnership  which  has  fixed  its  own  fiscal 
year,  the  percentage  determined  for  the  calendar  year  ending  during  such 
fiscal  year  shall  be  used. 

53  (B)  The  tax  shall  be  assessed  upon  the    basis    of    the    deduction  de- 
termined as  provided  in  section  two  hundred  and  three, 

54  but  the  taxpayer  claiming  the  benefit  of  this  section  may  at   the    time  of 
making  the  return  file  a  claim  for  abatement  of  the  amount  by  which  the 
tax  so  assessed  exceeds  a  tax  computed  upon  the  basis  of   the    deduction 
determined  as  provided  in  this  section. 

55  In  such  event,  collection  of  the  part  of  the  tax  covered  by  such  claim  for 
abatement  shall  not  be  made  until  the  claim  is  decided,  but  if  in  the  judg- 
ment of  the  commissioner  of  internal  revenue,  the  interests  of  the  United 
States  would  be  jeopardized  thereby  he  may  require  the  claimant  to  give  a 
bond  in  such  amount   and    with    such    sureties  as  the  commissioner  may 
think  wise  to  safeguard  such  interests,  conditioned  for  the  payment  of  any 
tax  found  to  be  due,  with  the  interest  thereon,  and  if  such  bond,  satisfac- 
tory to  the  commissioner,  is  not  given  within  such  time  as  he  prescribes, 
the  full  amount  of  tax  assessed  shall    be  collected  and  the  amount  over- 
paid, if  any,  shall  upon  final  decision  of  the  application  be  refunded  as  a 
tax  erroneously  or  illegally  collected. 

56  Sec.  206.  That  for  the  purposes  of  this  title  the  net  income  of  a  cor- 
poration shall  be  ascertained  and  returned 

57  (A)  for  the  calendar  years  nineteen  hundred    and    eleven    and    nineteen 
hundred  and  twelve  upon  the  same  basis  and  in  the  same  manner  as  pro- 
vided in  section  thirty-eight  of  the  Act  entitled  "An  Act  to  Provide  Rev- 
enue, equalize  duties,  and  encourage  the  industries  of  the  United  States, 
and  for  other  purposes,"  approved    August    fifth,    nineteen    hundred    and 
nine,  except  that  income  taxes  paid  by  it  within  the  year  imposed  by  the 
authority  of  the  United  States  shall  be  included ; 

58  (B)  for  the  calendar  year  nineteen  hundred  and  thirteen  upon  the  same 
basis  and  in  the  same  manner  as  provided  in  section  II  of  the  Act  entitled 
"An  Act  to  reduce  tariff  duties  and  to  provide  revenue  for  the  government, 
and  for  other  purposes,"  approved  October  third,  nineteen  hundred  and 
thirteen,  except  that  income  taxes  paid  by  it  within  the  year  imposed  by 
the  authority  of  the  United  States  shall  be  included,  and  except  that  the 
amounts  received  by  it  as  dividends  upon  the  stock  or  from  the  net  earn- 
ings of  other  corporations,  joint-stock  companies  or  associations,  or  in- 
surance companies,  subject  to  the  tax  imposed  by  Section  II  of  such  Act 
of  October  third,  nineteen  hundred  and  thirteen,  shall  be  deducted;  and 

59  (C)  for  the  taxable  year  upon  the  same  basis  and  in  the  same  manner  as 
provided  in  Title  I  of  the  Act  entitled    "An  Act   to  increase  the  revenue, 
and  for  other  purposes,"  approved  September    eighth,    nineteen    hundred 
and  sixteen,  as  amended  by  this  Act,  except  that  the  amounts  received  by 
it  as  dividends  upon  the  stock  or  from  the  net  earnings  of  other  corpora- 
tions, joint-stock  companies  or  associations,  or  insurance  companies,  sub- 
ject to  the  tax  imposed  by  Title  I  of  such  Act  of  September  eighth,  nine- 
teen hundred  and  sixteen,  shall  be  deducted. 


APPENDIX— TEXT    OF    LAW  29 

60  The  net  income  of  a  partnership  or  individual  shall    be    ascertained 
and  returned  for  the  calendar  years  nineteen  hundred    and    eleven,    nine- 
teen hundred  and  twelve,  and  nineteen  hundred  and  thirteen,  and  for  the 
taxable  year,  upon  the  same  basis  and  in  the  same  manner  as  provided  in 
Title  I  of  such  Act  of  September  eighth,  nineteen  hundred  and  sixteen,  as 
amended  by  this  Act,  except  that  the  credit  allowed  by  subdivision  (B)  of 
Section  five  of  such  Act  shall  be  deducted. 

61  There  shall  be  allowed 

62  (A)  in  the  case  of  a  domestic  partnership  the  same  deductions  as  allowed 
to  individuals  in  subdivision  (A)  of  section  five  of  such  Act  of  September 
eighth,  nineteen  hundred  and  sixteen,  as  amended  by  this  Act;  and 

63  (B)  in  the  case  of  a  foreign  partnership  the  same  deductions  as  allowed 
to  individuals  in  subdivision   (A)  of  section  six  of  such  Act  as  amended 
by  this  Act. 

64  Sec.  207.  That  as  used  in  this  title  the  term    "invested    capital"    for 
any  year  means  the  average  invested  capital  for  the  year,  as  defined  and 
limited  in  this  title,  averaged  monthly. 

65  As  used  in  this  title  "invested  capital"  does  not  include  stocks,  bonds 
(other  than  obligations  of  the  United  States),  or  other  assets,  the  income 
from  which  is  not  subject  to  the  tax  imposed  by  this  title,  nor  money  or 
other  property  borrowed,  and  means,  subject  to  the  above  limitations: 

66  (A)   In  the  case  of  a  corporation  or  partnership: 

67  (1)  Actual  cash  paid  in, 

68  (2)  the  actual  cash  value  of  tangible  property  paid    in    other    than    cash, 
for  stock  or  shares  in  such  corporation  or  partnership,  at  the  time  of  such 
payment  (but  in  case  such  tangible  property  was  paid  in  prior  to  January 
first,  nineteen  hundred  and  fourteen,  the  actual  cash  value  of  such  prop- 
erty as  of  January  first,  nineteen  hundred  and  fourteen,  but  in  no  case  to 
exceed  the  par  value  of  the  original  stock    or    shares  specifically  issued 
therefor),  and 

69  (3)   paid  in  or  earned  surplus  and  undivided  profits  used  or  employed  in 
the  business,  exclusive  of  undivided    profits    earned    during    the    taxable 
year: 

70  Provided,  that 

71  (a)   the  actual  cash  value  of  patents  and  copyrights  paid  in  for  stock  or 
shares  in  such  corporation  or  partnership,  at  the  time  of  such  payment, 
shall  be  included  as  invested  capital,  but  not  to  exceed  the  par  value  of 
such  stock  or  shares  at  the  time  of  such  payment,  and 

72  (b)   the  good  will,  trade  marks,  trade  brands,  the  franchise  of  a  corpora- 
tion or  partnership,  or  other  intangible  property,  shall  be  included  as  in- 
vested capital  if  the  corporation  or  partnership  made  payment  bona  fide 
therefor  specifically   as    such    in    cash    or   tangible  property,  the  value  of 
such  good  will,  trade-mark,  trade  brand,  franchise,  or  intangible  property, 
not  to  exceed  the  actual  cash  or  actual  cash  value  of  the  tangible  property 
paid  therefor  at  the  time  of  such  payment;    but    good    will,  trade-marks, 
trade  brands,  franchise  of  a  corporation  or  partnership,  or  other  intangi- 
ble property,  bona  fide  purchased,  prior  to  March  third,  nineteen  hundred 
and  seventeen,  for  and  with  interests  or  shares    in    a    partnership  or  for 
and  with  shares    in  the    capital    stock    of    a    corporation   (issued  prior  to 
March  third,  nineteen  hundred  and  seventeen),    in  an  amount  not  to  ex- 
ceed, on  March  third,  nineteen  hundred  and  seventeen,  twenty  per  centum 
of  the  total  interests  or  shares  in  the  partnership  or  of  the  total  shares  of 
the  actual  stock  of  the  corporation,  shall  be  included  in  invested  capital 
at  a  value  not  to  exceed  the  actual  cash  value  at  the    time   of   such   pur- 
chase, and  in  case  of  issue  of  stock  therefor  not  to  exceed  the  par  value  of 
such  stock; 

73  (B)   In  the  case  of  an  individual, 

74  (1)  actual  cash  paid  into  the  trade  or  business,  and 

75  (2)  the  actual  cash  value  of  tangible  property  paid  into  the  trade  or  busi- 
ness, other  than  cash,  at  the  time  of  such  payment  (but  in  case  such  tan- 
gible property  was  paid  in    prior   to    January  first,  nineteen  hundred  and 


30  APPENDIX— TEXT    OF    LAW 

fourteen,  the  actual  cash  value  of  such  property  as  of  January  first,  nine 
teen  hundred  and  fourteen),  and 

76  (3)  the  actual  cash  value  of  patents,  copyrights,  good  will,  trade  marks, 
trade  brands,  franchises,  or  other  intangible  property,  paid  into  the  trade 
or  business,  at  the  time  of  such  payment,  if  payment  was  made  therefor 
specifically  as  such  in  cash  or  tangible  property,  not  to  exceed  the  actual 
cash  or  actual  cash  value  of  the  tangible  property  bona  fide  paid  therefor 
at  the  time  of  such  payment. 

77  In  the  case  of  a  foreign  corporation  or  partnership  or  of  a  nonresident 
alien  individual  the  term  "invested  capital"  means  that  proportion  of  the 
entire  invested  capital,  as  defined  and  limited  in  this  title,  which  the  net 
income  from  sources  within  the  United  States  bears  to  the  entire  net  in- 
come. 

78  Sec.  208.  That  in  case  of  the  reorganization,  consolidation,  or  change 
of  ownership  of  a  trade  or  business  after  March  third,  nineteen  hundred 
and  seventeen,  if  an  interest  or  control  in  such  trade  or  business  of  fifty 
per  centum  or  more  remains  in  control  of  the  same  persons,  corporations, 
associations,  partnerships,  or  any    of   them,    then  in  ascertaining  the  in- 
vested capital  of  the  trade  or  business  no  asset  transferred    or   received 
from  the  prior  trade  or  business  shall   be  allowed   a   greater  value   than 
would  have  been  allowed  under  this  title  in  computing  the  invested  capital 
of  such  prior  trade  or  business  if  such  asset  had  not  been  so  transferred 
or  received,  unless  such  asset  was  paid  for  specifically  as  such,  in  cash  or 
tangible  property,  and  then  not  to  exceed  the  actual  cash  or  actual  cash 
value  of  the  tangible  property  paid  therefor  at  the  time  of  such  payment. 

79  Sec.  209.  That  in  the  case  of  a  trade  or  business  having  no  invested 
capital  or  not  more  than  a  nominal  capital  there  shall  be  levied,  assessed, 
collected,  and  paid,  in  addition  to  the  taxes  under  existing  law  and  under 
this  Act,  in  lieu  of  the  tax  imposed  by  section  two  hundred  and  one,  a  tax 
equivalent  to  eight  per  centum  of  the  net  income   of   such  trade  or  busi- 
ness, in  excess  of  the  following  deductions: 

80  In  the  case  of  a  domestic  corporation,  $3,000,  and 

81  in  the  case  of   a   domestic  partnership,   or   a   citizen    or   resident   of   the 
United  States,  $6,000, 

82  in  the  case  of  all  other  trades  or  business,  no  deduction. 

83  Sec.  210.  That  if  the  Secretary  of  the  Treasury  is  unable  in  any  case 
satisfactorily  to  determine  the  invested  capital,  the  amount  of  the  deduc- 
tion shall  be  the  sum  of 

84  (1)  an  amount  equal  to  the  same  proportion    of   the   net   income    of   the 
trade  or  business  received  during  the  taxable  year  as  the  proportion  which 
the  average  deduction  (determined    in   the    same   manner  as  provided  in 
section  two  hundred  and  three,    without    including    the    $3,000    or    $6,000 
therein  referred  to)  for  the  same  calendar  year  of  representative  corpora- 
tions, partnerships,  and  individuals,  engaged  in  a  like  or  similar  trade  or 
business,  bears  to  the  total  net  income  of  the  trade  or  business  received 
by  such  corporations,  partnerships,  and  individuals,  plus 

85  (2)  in  the  case  of  a  domestic  corporation  $3,000,  and 

86  in  the  case  of  a  domestic  partnership  or  a  citizen  or  resident  of  the  United 
States  $6,000. 

87  For  the  purpose  of  this  section  the  proportion  between  the  deduction 
and  the  net  income  in  each  trade  or  business  shall  be  determined  by  the 
commissioner   of   internal  revenue    in    accordance    with   regulations    pre- 
scribed by  him,  with  the  approval  of  the  Secretary  of  the  Treasury. 

88  In  the  case  of  a  corporation  or  partnership  which  has  fixed  its  own  fiscal 
year,  the  proportion  determined  for  the  calendar  year  ending  during  such 
fiscal  year  shall  be  used. 

89  Sec.  211.  That  every  foreign  partnership  having  a  net  income  of  $3,000 
or  more  for  the  taxable  year,  and 

1)0     every  domestic  partnership  having  a  net  income  of  $6,000  or  more  for  the 

taxable  year, 
91     shall  render  a  correct  return  of  the  income  of  the  trade  or  business  for  the 

taxable  year, 


APPENDIX— TEXT    OF    LAW  31 

92  setting  forth  specifically  the  gross  income  for  such  year,  and  the  deduc- 
tions allowed  in  this  title. 

93  Such  returns  shall  be  rendered  at  the  same  time  and  in  the  same  manner 
as  is  prescribed  for  income-tax  returns  under  Title  I  of  such  Act  of  Sep- 
tember eighth,  nineteen  hundred  and  sixteen,  as  amended  by  this  Act. 

94  Sec.  212.  That    all    administrative,  special,  and  general  provisions  of 
law,  including  the  laws  in  relation  to  the  assessment,  remission,  collec- 
tion, and  refund  of  internal-revenue  taxes  not  heretofore  specifically  re- 
pealed, and  not  inconsistent  with  the  provisions  of  this  title,  are  hereby 
extended  and  made  applicable  to  all  the  provisions  of  this  title  and  to  the 
tax  herein  imposed,  and  all  provisions  of  Title  I  of  such  Act  of  September 
eighth,  nineteen  hundred  and  sixteen,  as  amended  by  this  Act,  relating  to 
returns  and  payment  of  the  tax  therein  imposed,  including  penalties,  are 
hereby  made  applicable  to  the  tax  imposed  by  this  title. 

95  Sec.  213.  That  the  commissioner    of    internal    revenue,  with  the    ap- 
proval of  the  Secretary  of  the  Treasury,  shall  make  all  necessary  regula- 
tions for  carrying  out  the  provisions  of  this  title,  and 

96  may    require    any    corporation,  partnership,  or    individual,    subject  to  the 
provisions  of  this  title,  to  furnish  him  with  such  facts,  data,  and  informa- 
tion as  in  his  judgment  are  necessary  to  collect  the  tax  imposed  by  this 
title. 

97  Sec.  214.  That  Title  II   (sections  two  hundred    to    two    hundred    and 
seven,  inclusive)  of  the  Act  entitled  "An  Act  to  provide  increased  revenue 
to  defray  the  expenses  of  the  increased  appropriations  for  the  army  and 
navy,  and  the  extensions  of  fortifications,  and    for    other   purposes,"    ap- 
proved March  third,  nineteen  hundred  and  seventeen,  is  hereby  repealed. 

98  Any  amount  heretofore  or  hereafter   paid    on   account  of  the  tax  im- 
posed by  such  Title  II,  shall  be  credited  toward  the  payment   of   the   tax 
imposed  by  this  title,  and  if  the  amount  so  paid    exceeds    the    amount   of 
such  tax  the  excess  shall  be  refunded  as  a  tax  erroneously  or  illegally  col- 
lected. 

99  Subdivision  (1)  of  section  three  hundred  and  one  of  such  Act  of  Sep- 
tember eighth,  nineteen  hundred  and  sixteen,  is  hereby  amended  so  that 
the  rate  of  tax  for  the  taxable  year  nineteen  hundred  and  seventeen  shall 
be  ten  per  centum  instead  of  twelve  and  one-half  per  centum,  as  therein 
provided. 

100  Subdivision  (2)  of  such  section  is  hereby  amended  to  read  as  follows: 

"(2)   This  section  shall  cease  to  be  of  effect  on  and  after  January  first, 
nineteen  hundred  and  eighteen." 


THE   WAR  TAX  ON   BEVERAGES 


Title  III  of  the  Act  of  October  3,  1917. 


Sec.  300. — That  on  and  after  the  passage  of  this  Act  there  shall  be  levied 
and  collected  on  all  distilled  spirits  in  bond  at  that  time  or  that  have  been  or 
that  may  be  then  or  thereafter  produced  in  or  imported  into  the  United  States, 
except  such  distilled  spirits  as  are  subject  to  the  tax  provided  in  section  three 
hundred  and  three,  in  addition  to  the  tax  now  imposed  by  law,  a  tax  of  $1.10 
(or,  if  withdrawn  for  beverage  purposes  or  for  use  in  the  manufacture  or  pro- 
duction of  any  article  used  or  intended  for  use  as  a  beverage,  a  tax  of  $2.10)  on 
each  proof  gallon,  or  wine  gallon  when  below  proof,  and  a  proportionate  tax  at 
a  like  rate  on  all  fractional  parts  of  such  proof  or  wine  gallon,  to  be  paid  by  the 


32  APPENDIX— TEXT    OF    LA\Y 

distiller  or  importer  when  withdrawn,    and    collected  under    the    provisions  of 
existing  law. 

That  in  addition  to  the  tax  under  existing  law  there  shall  be  levied  and 
collected  upon  all  perfumes  hereafter  imported  into  the  United  States  contain- 
ing distilled  spirits,  a  tax  of  $1.10  per  wine  gallon,  and  a  proportionate  tax  at  a 
like  rate  on  all  fractional  parts  of  such  wine  gallon.  Such  tax  shall  be  collected 
by  the  collector  of  customs  and  deposited  as  internal-revenue  collections,  under 
such  rules  and  regulations  as  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary,  may  prescribe. 

IMPORTATION   OF  SPIRITS. 

That  no  distilled  spirits  produced  after  the  passage  of  this  Act  shall  be 
imported  into  the  United  States  from  any  foreign  country,  or  from  the  West 
Indian  Islands  recently  acquired  from  Denmark  (unless  produced  from  pro- 
ducts the  growth  of  such  islands,  and  not  then  into  any  State  or  Territory  or 
District  of  the  United  States  in  which  the  manufacture  or  sale  of  intoxicating 
liquor  is  prohibited),  or  from  Porto  Rico,  or  the  Philippine  Islands.  Under 
such  rules,  regulations,  and  bonds  as  the  Secretary  of  the  Treasury  may  pre- 
scribe, the  provisions  of  this  section  shall  not  apply  to  distilled  spirits  import- 
ed for  other  than  (1)  beverage  purposes  or  (2)  use  in  the  manufacture  or  pro- 
duction of  any  article  used  or  intended  for  use  as  a  beverage. 

MOVEMENT   OF  SPIRITS. 

Sec.  302.  That  at  registered  distilleries  producing  alcohol,  or  other  high- 
proof  spirits,  packages  may  be  filled  with  such  spirits  reduced  to  not  less  than 
one  hundred  proof  from  the  receiving  cisterns  and  tax  paid  without  being  en- 
tered into  bonded  warehouse.  Such  spirits  may  also  be  transferred  from  the 
receiving  cisterns  at  such  distilleries,  by  means  of  pipe  lines,  direct  to  storage 
tanks  in  the  bonded  warehouse  and  may  be  warehoused  in  such  storage  tanks. 
Such  spirits  may  be  also  transferred  in  tanks  or  tank  cars  to  general  bonded 
warehouses  for  storage  therein,  either  in  storage  tanks  in  such  warehouses  or 
in  the  tanks  in  which  they  were  transferred.  Such  spirits  may  also  be  trans- 
ferred after  tax  payment  from  receiving  cisterns  or  warehouse  storage  tanks  to 
tanks  or  tank  cars  and  may  be  transported  in  such  tanks  or  tank  cars  to  the 
premises  of  rectifiers  of  spirits.  The  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  is  hereby  empowered  to  prescribe  all 
necessary  regulations  relating  to  the  drawing  off,  transferring,  gauging,  stor- 
ing and  transporting  of  such  spirits;  the  records  to  be  kept  and  returns  to  be 
made;  the  size  and  kind  of  packages  and  tanks  to  be  used;  the  marking,  brand- 
ing, numbering  and  stamping  of  such  packages  and  tanks;  the  kinds  of  stamps, 
if  any,  to  be  used;  and  the  time  and  manner  of  paying  the  tax;  the  kind  of 
bond  and  the  penal  sum  of  same.  The  tax  prescribed  by  law  must  be  paid 
before  such  spirits  are  removed  from  the  distillery  premises,  or  from  general 
bonded  warehouse  in  the  case  of  spirits  transferred  thereto,  except  as  other- 
wise provided  by  law. 

Under  such  regulations  as  the  Commissioner  of  Internal  Revenue,  with  the 
approval  of  the  Secretary  of  the  Treasury,  may  prescribe,  distilled  spirits  may 
hereafter  be  drawn  from  receiving  cisterns  and  deposited  in  distillery  ware- 
houses without  having  affixed  to  the  packages  containing  the  same  distillery 
warehouse  stamps,  and  such  packages,  when  so  deposited  in  warehouse,  may 
be  withdrawn  therefrom  on  the  original  gauge  where  the  same  have  remained 
in  such  warehouse  for  a  period  not  exceeding  thirty  days  from  the  date  of  de- 
posit. 

DENATURED  ALCOHOL. 

Under  such  regulations  as  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  may  prescribe,  the  manufacture, 
warehousing,  withdrawal,  and  shipment,  under  the  provisions  of  existing  law, 
of  ethyl  alcohol  for  other  than  (1)  beverage  purposes  or  (2)  use  in  the  manu- 
facture or  production  of  any  article  used  or  intended  for  use  as  a  beverage, 
and  denatured  alcohol,  may  be  exempted  from  the  provisions  of  section  thirty- 
two  hundred  and  eighty-three,  Revised  Statutes  of  the  United  States. 


APPENDIX— TEXT    OF    LAW  33 

Under  such  regulations  as  the  Commissioner  of  Internal  Revenue,  with 
ihe  approval  of  the  Secretary  of  the  Treasury,  may  prescribe,  manufacturers 
of  ethyl  alcohol  for  other  than  beverage  purposes  may  be  granted  permission 
under  the  provisions  of  section  thirty-two  hundred  and  eighty-five,  Revised 
Statutes  of  the  United  States,  to  fill  fermenting  tubs  in  a  sweet-mash  distillery 
not  oftener  than  once  in  forty-eight  hours. 

IN    HANDS  OF  DEALERS. 

Sec.  303.  That  upon  all  distilled  spirits  produced  in  or  imported  into  the 
United  States  upon  which  the  tax  now  imposed  by  law  has  been  paid,  and 
which,  on  the  day  this  Act  is  passed,  are  held  by  a  retailer  in  a  quantity  in  ex- 
cess of  fifty  gallons  in  the  aggregate,  or  by  any  other  person,  corporation,  part- 
nership, or  association  in  any  quantity,  and  which  are  intended  for  sale,  there 
shall  be  levied,  assessed,  collected,  and  paid  a  tax  of  $1.10  (or,  if  intended  for 
sale  for  beverage  purposes  or  for  use  in  the  manufacture  or  production  of  any 
article  used  or  intended  for  use  as  a  beverage,  a  tax  of  $2.10)  on  each  proof 
gallon,  and  a  proportionate  tax  at  a  like  rate  on  all  fractional  parts  of  such 
proof  gallon:  Provided,  That  the  tax  on  such  distilled  spirits  in  the  custody  of 
a  court  of  bankruptcy  in  insolvency  proceedings  on  June  first,  nineteen 
hundred  and  seventeen,  shall  be  paid  by  the  person  to  whom  the  court  delivers 
such  distilled  spirits  at  the  time  of  such  delivery,  to  the  extent  that  the  amount 
thus  delivered  exceeds  the  fifty  gallons  hereinbefore  provided. 

RECTIFIED  SPIRITS. 

Sec.  304.  That  in  addition  to  the  tax  now  imposed  or  imposed  by  this  Act 
on  distilled  spirits  there  shall  be  levied,  assessed,  collected,  and  paid  a  tax  of 
15  cents  on  each  proof  gallon  and  a  proportionate  tax  at  a  like  rate  on  all  frac- 
tional parts  of  such  proof  gallon  on  all  distilled  spirits  of  wines  hereafter  rec- 
tified, purified,  or  refined  in  such  manner,  and  on  all  mixtures  hereafter  pro- 
duced in  such  manner,  that  the  person  so  rectifying,  purifying,  refining,  or 
mixing  the  same  is  a  rectifier  within  the  meaning  of  section  thirty-two  hundred 
and  forty-four.  Revised  Statutes,  as  amended,  and  on  all  such  articles  in  the 
possession  of  the  rectifier  on  the  day  this  Act  is  passed:  Provided,  That  this 
tax  shall  not  apply  to  gin  produced  by  the  redistillation  of  a  pure  spirit  over 
juniper  berries  and  other  aromatics. 

When  the  process  of  rectification  is  completed  and  the  tax  prescribed  by 
this  section  has  been  paid,  it  shall  be  unlawful  for  the  rectifier  or  other  dealer 
to  reduce  in  proof  or  increase  in  volume  such  spirits  or  wine  by  the  addition 
of  water  or  other  substance;  nothing  herein  contained  shall,  however,  prevent 
a  rectifier  from  using  again  in  the  process  of  rectification  spirits  already  recti- 
fied and  upon  which  the  tax  has  theretofore  been  paid. 

The  tax  imposed  by  this  section  shall  not  attach  to  cordials  or  liqueurs  on 
which  a  tax  is  imposed  and  paid  under  the  Act  entitled  "An  Act  to  increase 
the  revenue,  and  for  other  purposes,"  approved  September  eighth,  nineteen 
hundred  and  sixteen,  nor  to  the.  mixing  and  blending  of  wines,  where  such 
blending  is  for  the  sole  purpose  of  perfecting  such  wines  according  to  com- 
mercial standards,  nor  to  blends  made  exclusively  of  two  or  more  pure  straight 
whiskies  aged  in  wood  for  a  period  not  less  than  four  years  and  without  the 
addition  of  coloring  or  flavoring  matter  or  any  other  substance  than  pure 
water  and  if  not  reduced  below  ninety  proof:  Provided,  That  such  blended 
whiskies  shall  be  exempt  from  tax  under  this  section  only  when  compounded 
under  the  immediate  supervision  of  a  revenue  officer,  in  such  tanks  and  under 
such  conditions  and  supervision  as  the  Commissioner  of  Internal  Revenue,  with 
the  approval  of  the  Secretary  of  the  Treasury,  may  prescribe. 

All  distilled  spirits  taxable  under  this  section  shall  be  subject  to  uniform 
regulations  concerning  the  use  thereof  in  the  manufacture,  blending,  com- 
pounding, mixing,  marking,  branding,  and  sale  of  whisky  and  rectified  spirits, 
and  no  discrimination  whatsoever  shall  be  made  by  reason  of  a  difference  in 
the  character  of  the  material  from  which  same  may  have  been  produced. 

The  business  of  a  rectifier  of  spirits  shall  be  carried  on,  and  the  tax  on 
rectified  spirits  shall  be  paid,  under  such  rules,  regulations,  and  bonds  as  may 
be  prescribed  by  the  Commissioner  of  Internal  Revenue,  with  the  approval  of 
the  Secretary  of  the  Treasury. 


34  APPENDIX— TEXT    OF    LAW 

Any  person  violating  any  of  the  provisions  of  this  section  shall  be  deemed 
to  be  guilty  of  a  misdemeanor  and,  upon  conviction,  shall  be  fined  not  more 
than  $1,000  or  imprisoned  not  more  than  two  years.  He  shall,  in  addition,  be 
liable  to  double  the  tax  evaded  together  with  the  tax,  to  be  collected  by  assess- 
ment or  on  any  bond  given. 

STAMPS  DISPENSED  WITH. 

Sec.  305.  That  hereafter  collectors  of  internal  revenue  shall  not  furnish 
wholesale  liquor  dealer's  stamps  in  lieu  of  and  in  exchange  for  stamps  for  recti- 
fied spirits  unless  the  package  covered  by  stamp  for  rectified  spirits  is  to  be 
broken  into  smaller  packages.  . 

The  Commissioner  of  Internal  Revenue,  with  the  approval  of  the  Secretary 
of  the  Treasury,  is  authorized  to  discontinue  the  use  of  the  following  stamps 
whenever  in  his  judgment  the  interests  of  the  Government  will  be  subserved 
thereby: 

Distillery  warehouse,  special  bonded  warehouse,  special  bonded  reware- 
house,  general  bonded  warehouse,  general  bonded  retransfer,  transfer  brandy, 
export  tobacco,  export  cigars,  export  oleomargarine  and  export  fermented 
liquor  stamps. 

EQUIPMENT    REQUIRED. 

Sec.  306.  That  the  Commissioner  of  Internal  Revenue,  with  the  approval  of 
the  Secretary  of  the  Treasury,  is  hereby  authorized  to  require  at  distilleries, 
breweries,  rectifying  houses,  and  wherever  else  in  his  judgment  such  action  may 
be  deemed  advisable,  the  installation  of  meters,  tanks,  pipes,  or  any  other  ap- 
paratus for  the  purpose  of  protecting  the  revenue,  and  such  meters,  tanks,  and 
pipes  and  all  necessary  labor  incident  thereto  shall  be  at  the  expense  of  the 
person,  corporation,  partnership,  or  association  on  whose  premises  the  instal- 
lation is  required.  Any  such  person,  corporation,  partnership,  or  association 
refusing  or  neglecting  to  install  such  apparatus  when  so  required  by  the  com- 
missioner shall  not  be  permitted  to  conduct  business  on  such  premises. 

BEER   AND   OTHER    FERMENTED    LIQUORS. 

Sec.  307.  That  on  and  after  the  passage  of  this  Act  there  shall  be  levied 
and  collected  on  all  beer,  lager  beer,  ale,  porter,  and  other  similar  fermented 
liquor,  containing  one-half  per  centum  or  more  of  alcohol,  brewed  or  manu- 
factured and  sold,  or  stored  in  warehouse,  or  removed  for  consumption  or  sale, 
within  the  United  States,  by  whatever  name  such  liquors  may  be  called,  in 
addition  to  the  tax  now  imposed  by  law,  a  tax  of  $1.50  for  every  barrel  contain- 
ing not  more  than  thirty-one  gallons,  and  at  a  like  rate  for  any  other  quantity 
or  for  the  fractional  parts  of  a  barrel  authorized  and  defined  by  law. 

Sec.  308.  That  from  and  after  the  passage  of  this  Act  taxable  fermented 
liquors  may  be  conveyed  without  payment  of  tax  from  the  brewery  premises 
where  produced  to  a  contiguous  industrial  distillery  of  either  class  established 
under  the  Act  of  October  third,  nineteen  hundred  and  thirteen,  to  be  used  as 
distilling  material,  and  the  residue  from  such  distillation,  containing  less  than 
one-half  of  one  per  centum  of  alcohol  by  volume,  which  is  to  be  used  in  making 
beverages,  may  be  manipulated  by  cooling,  flavoring,  carbonating,  settling,  and 
filtering  on  the  distillery  premises  or  elsewhere. 

The  removal  of  the  taxable  fermented  liquor  from  the  brewery  to  the  dis- 
tillery and  the  operation  of  the  distillery  and  removal  of  the  residue  therefrom 
shall  be  under  the  supervision  of  such  officer  or  officers  as  the  Commissioner 
of  Internal  Revenue  shall  deem  proper,  and  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury,  is  hereby 
authorized  to  make  such  regulations  from  time  to  time  as  may  be  necessary  to 
give  force  and  effect  to  this  section  and  to  safeguard  the  revenue. 

WINES    HEREAFTER    REMOVED. 

Sec.  309.  That  upon  all  still  wines,  including  vermuth,  and  upon  all  cham- 
pagne and  other  sparkling  wines,  liqueurs,  cordials,  artificial  or  imitation  wines 
or  compounds  sold  as  wine,  produced  in  or  imported  into  the  United  States, 
and  hereafter  removed  from  the  customhouse,  place  of  manufacture,  or  from 


APPENDIX— TEXT    OF    LAW  35 

bonded  premises  for  sale  or  consumption,  there  shall  be  levied  and  collected, 
in  addition  to  the  tax  now  imposed  by  law  upon  such  articles,  a  tax  equal  to 
such  tax,  to  be  levied,  collected,  and  paid  under  the  provisions  of  existing  law. 

IN   HANDS  OF  DEALERS. 

Sec.  310.  That  upon  all  articles  specified  in  section  three  hundred  and  nine 
upon  which  the  tax  now  imposed  by  law  has  been  paid  and  which  are  on  the 
day  this  Act  is  passed  held  in  excess  of  twenty-five  gallons  in  the  aggregate  of 
such  articles  and  intended  for  sale,  there  shall  be  levied,  collected,  and  paid  a 
tax  equal  to  the  tax  imposed  by  such  section. 

BRANDY  FOR   FORTIFICATION. 

Sec.  311.  That  upon  all  grape  brandy  or  wine  spirits  withdrawn  by  a  pro- 
ducer of  wines  from  any  fruit  distillery  or  special  bonded  warehouse  under  sub- 
division (c)  of  section  four  hundred  and  two  of  the  Act  entitled  "An  Act  to  in- 
crease the  revenue,  and  for  other  purposes,"  approved  September  eighth,  nine- 
teen hundred  and  sixteen,  there  shall  be  levied,  assessed,  collected,  and  paid  in 
addition  to  the  tax  therein  imposed,  a  tax  equal  to  double  such  tax,  to  be 
assessed,  collected,  and  paid  under  the  provisions  of  existing  law. 

EXTRA  TAX  ON  SWEET  WINES. 

Sec.  312.  That  upon  all  sweet  wines  held  for  sale  by  the  producer  thereof 
upon  the  day  this  Act  is  passed  there  shall  be  levied,  assessed,  collected,  and 
paid  an  additional  tax  equivalent  to  10  cents  per  proof  gallon  upon  the  grape 
brandy  or  wine  spirits  used  in  the  fortification  of  such  wine,  and  an  additional 
tax  of  20  cents  per  proof  gallon  shall  be  levied,  assessed,  collected,  and  paid 
upon  all  grape  brandy  or  wine  spirits  withdrawn  by  a  producer  of  sweet  wines 
for  the  purpose  of  fortifying  such  wines  and  not  so  used  prior  to  the  passage 
of  this  Act. 

SIRUPS  AND   EXTRACTS. 

Sec.  313.  That  there  shall  be  levied,  assessed,  collected,  and  paid — 

(a)  Upon  all  prepared  sirups  or  extracts   (intended  for  use  in  the  manu- 
facture or  production  of  beverages,  commonly  known  as  soft  drinks,  by  soda 
fountains,  bottling  establishments,  and  other  similar  places)  sold  by  the  manu- 
facturer, producer,  or  importer  thereof,  if  so  sold  for  not  more  than  $1.30  per 
gallon,  a  tax  of  5  cents  per  gallon;  if  so  sold  for  more  than  $1.30  and  not  more 
than  $2  per  gallon,  a  tax  of  8  cents  per  gallon;  if  so  sold  for  more  than  $2  and 
not  more  than  $3  per  gallon,  a  tax  of  10  cents  per  gallon;  if  so  sold  for  more 
than  $3  and  not  more  than  $4  per  gallon,  a  tax  of  15  cents  per  gallon;  and  if  so 
sold  for  more  than  $4  per  gallon,  a  tax  of  20  cents  per  gallon;  and 

SOFT  DRINKS. 

(b)  Upon  all  unfermented  grape  juice,    soft    drinks    or    artificial    mineral 
waters  (not  carbonated),  and  fermented  liquors  containing  less  than  one-half 
per  centum  of  alcohol,  sold  by  the  manufacturer,  producer,  or  importer  thereof, 
in  bottles  or  other  closed  containers,  and  upon  all  ginger  ale,  root  beer,  sarsa- 
parilla,  pop,  and  other  carbonated  waters  or  beverages,  manufactured  and  sold 
by  the  manufacturer,  producer,  or  importer  of  the  carbonic  acid    gas    used  in 
carbonating  the  same,  a  tax  of  1  cent  per  gallon;  and 

(c)  Upon  all  natural  mineral  waters  or  table  waters,  sold  by  the  producer, 
bottler,  or  importer  thereof,  in  bottles  or  other  closed  containers,    at    over  10 
cents  per  gallon,  a  tax  of  1  cent  per  gallon. 

Sec.  314.  That  each  such  manufacturer,  producer,  bottler,  or  importer  shall 
make  monthly  returns  under  oath  to  the  collector  of  internal  revenue  for  the 
district  in  which  is  located  the  principal  place  of  business,  containing  such  in- 
formation necessary  for  the  assessment  of  the  tax,  and  at  such  times  and  in 
such  manner,  as  the  Commissioner  of  Internal  Revenue,  with  the  approval  of 
the  Secretary  of  the  Treasury,  may  by  regulation  prescribe. 

CARBONIC  ACID  GAS. 

Sec.  315.  That  upon  all  carbonic  acid  gas  in  drums  or  other  containers  (in- 
tended for  use  in  the  manufacture  or  production  of  carbonated  water  or  other 


36  APPENDIX— TEXT    OF    LAW 

drinks)  sold  by  the  manufacturer,  producer,  or  importer  thereof,  there  shall  be 
levied,  assessed,  collected,  and  paid  a  tax  of  5  cents  per  pound.  Such  tax  shall 
be  paid  by  the  purchaser  to  the  vendor  thereof  and  shall  be  collected,  returned, 
and  paid  to  the  United  States  by  such  vendor  in  the  same  manner  as  provide  1 
in  section  five  hundred  and  three. 


THE  WAR  TAX  ON 
CIGARS,   TOBACCO,  CIGARETTES 


Title  IV  of  the  Act  of  October  3,  1917. 


Cigars  and  Cigarettes. 

Sec.  400.  That  upon  cigars  and  cigarettes,  which  shall  be  manufactured 
and  sold,  or  removed  for  consumption  or  sale,  there  shall  be  levied  and  col 
lected,  in  addition  to  the  taxes  now  imposed  by  existing  law,  the  following 
taxes,  to  be  paid  by  the  manufacturer  or  importer  thereof:  (a)  on  cigars  of  ah 
descriptions  made  of  tobacco,  or  any  substitute  therefor,  and  weighing  not 
more  than  three  pounds  per  thousand,  25  cents  per  thousand;  (b)  on  cigars 
made  of  tobacco,  or  any  substitute  therefor,  and  weighing  more  than  three 
pounds  per  thousand,  if  manufactured  or  imported  to  retail  at  4  cents,  or  more 
each,  and  not  more  than  7  cents  each,  $1  per  thousand;  (c)  if  manufactured  or 
imported  to  retail  at  more  than  7  cents  each  and  not  more  than  15  cents  each, 
$3  per  thousand;  (d)  if  manufactured  or  imported  to  retail  at  more  than  15 
cents  each  and  not  more  than  20  cents  each,  $5  per  thousand;  (e)  if  manufac- 
tured or  imported  to  retail  at  more  than  20  cents  each,  $7  per  thousand;  Pro- 
vided, That  the  word  "retail"  as  used  in  this  section  shall  mean  the  ordinary 
retail  price  of  a  single  cigar,  and  that  the  Commissioner  of  Internal  Revenue 
may,  by  regulation,  require  the  manufacturer  or  importer  to  affix  to  each  box 
or  container  a  conspicuous  label  indicating  by  letter  the  clause  of  this  section 
under  which  the  cigars  therein  contained  have  been  tax-paid,  which  must  cor- 
respond with  the  tax-paid  stamp  on  said  box  or  container;  (f)  on  cigarettes 
made  of  tobacco,  or  any  substitute  therefor,  made  in  or  imported  into  the 
United  States,  and  weighing  not  more  than  three  pounds  per  thousand,  80  cents 
per  thousand;  weighing  more  than  three  pounds  per  thousand,  $1.20  per 
thousand. 

Every  manufacturer  of  cigarettes  (including  small  cigars  weighing  not 
more  than  three  pounds  per  thousand)  shall  put  up  all  the  cigarettes  and  such 
small  cigars  that  he  manufactures  or  has  manufactured  for  him,  and  sells  or 
removes  for  consumption  or  use,  in  packages  or  parcels  containing  five,  eight, 
ten,  twelve,  fifteen,  sixteen,  twenty,  twenty-four,  forty,  fifty,  eighty,  or  one 
hundred  cigarettes  each,  and  shall  securely  affix  to  each  of  said  packages  or 
parcels  a  suitable  stamp  denoting  the  tax  thereon  and  shall  properly  cancel  the 
same  prior  to  such  sale  or  removal  for  consumption  or  use  under  such  regula- 
tions as  the  Commissioner  of  Internal  Revenue,  with  the  approval  of  the  Sec- 
retary of  the  Treasury,  shall  prescribe;  and  all  cigarettes  imported  from  a 
foreign  country  shall  be  packed,  stamped,  and  the  stamps  canceled  in  a  like 
manner,  in  addition  to  the  import  stamp  indicating  inspection  of  the  custom- 
house before  they  are  withdrawn  therefrom. 

TOBACCO   AND  SNUFF. 

Sec.  401.  That  upon  all  tobacco  and  snuff  hereafter  manufactured  and  sold, 
or  removed  for  consumption  or  use,  there  shall  be  levied  and  collected,  in  addi- 
tion to  the  tax  now  imposed  by  law  upon  such  articles,  a  tax  of  5  cents  per 
pound,  to  be  levied,  collected,  and  paid  under  the  provisions  of  existing  law. 


APPENDIX— TEXT  .OF    LAW  37 

In  addition  to  the  packages  provided  for  under  existing  law,  manufactured 
tobacco  and  snuff  may  be  put  up  and  prepared  by  the  manufacturer  for  sale  or 
consumption,  in  packages  of  the  following  description:  Packages  containing 
one-eighth,  three-eighths,  five-eighths,  seven-eighths,  one  and  one-eighth,  one 
and  three-eighths,  one  and  five-eighths,  one  and  seven-eighths,  and  five  ounces. 

NEW    PACKAGES. 

Sec.  402.  That  sections  four  hundred,  four  hundred  and  one,  and  four 
hundred  and  four,  shall  take  effect  thirty  days  after  the  passage  of  this  Act: 
Provided,  That  after  the  passage  of  this  Act  and  before  the  expiration  of  the 
aforesaid  thirty  days,  cigarettes  and  manufactured  tobacco  and  snuff  may  be 
put  up  in  the  packages  now  provided  for  by  law  or  in  the  packages  provided  for 
in  sections  four  hundred  and  four  hundred  and  one. 

HELD   BY  DEALERS. 

Sec.  403.  That  there  shall  also  be  levied  and  collected,  upon  all  manufac- 
tured tobacco  and  snuff  in  excess  of  one  hundred  pounds,  or  upon  cigars,  or 
cigarettes  in  excess  of  one  thousand,  which  were  manufactured  or  imported, 
and  removed  from  factory  or  custom-house  prior  to  the  passage  of  this  Act, 
bearing  tax-paid  stamps  affixed  to  such  articles  for  the  payment  of  the  taxes 
thereon,  and  which  are,  on  the  day  after  this  Act  is  passed,  held  and  intended 
for  sale  by  any  person,  corporation,  partnership,  or  association,  and  upon  all 
manufactured  tobacco,  snuff,  cigars,  or  cigarettes,  removed  from  factory  or 
customs  house  after  the  passage  of  this  Act  but  prior  to  the  time  when  the  tax 
imposed  by  section  four  hundred  or  section  four  hundred  and  one  upon  such 
articles  takes  effect,  an  additional  tax  equal  to  one-half  the  tax  imposed  by 
such  sections  upon  such  articles. 

CIGARETTE   PAPERS. 

Sec.  404.  That  there  shall  be  levied,  assessed,  and  collected  upon  cigarette 
paper  made  up  into  packages,  books,  sets,  or  tubes,  made  up  in  or  imported 
into  the  United  States  and  intended  for  use  by  the  smoker  in  making  cigarettes 
the  following  taxes:  On  each  package,  book,  or  set,  containing  more  than 
twenty-five  but  not  more  than  fifty  papers,  one-half  of  1  cent;  containing  more 
than  fifty  but  not  more  than  one  hundred  papers,  1  cent;  containing  more  than 
one  hundred  papers,  1  cent  for  each  one  hundred  papers  or  fractional  part 
thereof;  and  upon  tubes,  2  cents  for  each  one  hundred  tubes  or  fractional  part 
thereof. 


THE  WAR  TAX  ON 

FREIGHT,   EXPRESS,  PASSENGER  TRANSPORTATION, 

TELEGRAPH  AND  TELEPHONE  MESSAGES 

AND  INSURANCE. 


Title  V  of  the  Act  of  October  3,  1917. 


FREIGHT— EXPRESS— PASSENGER   TICKETS— TELEGRAPH- 
TELEPHONE. 

Sec.  500.  That  from  and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected,  and  paid  (a)  a  tax 
equivalent  to  three  per  centum  of  the  amount  paid  for  the  transportation  by 
rail  or  water  or  by  any  form  of  mechanical  motor  power  when  in  competition 


38  APPENDIX— TEXT    OF    LAW 

with  carriers  by  rail  or  water  of  property  by  freight  consigned  from  one  point 
in  the  United  States  to  another;  (b)  a  tax  of  1  cent  for  each  20  cents,  or  frac- 
tion thereof,  paid  to  any  person,  corporation,  partnership,  or  association,  en- 
gaged in  the  business  of  transporting  parcels  or  packages  by  express  over  reg- 
ular routes  between  fixed  terminals,  for  the  transportation  of  any  package, 
parcel,  or  shipment  by  express  from  one  point  in  the  United  States  to  another: 
Provided,  That  nothing  herein  contained  shall  be  construed  to  require  the 
carrier  collecting  such  tax  to  list  separately  in  any  bill  of  lading,  freight  re- 
ceipt, or  other  similar  document,  the  amount  of  the  tax  herein  levied,  if  the 
total  amount  of  the  freight  and  tax  be  therein  stated;  (c)  a  tax  equivalent  to 
eight  per  centum  of  the  amount  paid  for  the  transportation  of  persons  by  rail 
or  water,  or  by  any  form  of  mechanical  motor  power  on  a  regular  established 
line  when  in  competition  with  carriers  by  rail  or  water,  from  one  point  in  the 
United  States  to  another  or  to  any  point  in  Canada  or  Mexico,  where  the  ticket 
therefor  is  sold  or  issued  in  the  United  States,  not  including  the  amount  paid 
for  commutation  or  season  tickets  for  trips  less  than  thirty  miles,  or  for  trans- 
portation the  fare  for  which  does  not  exceed  35  cents,  and  a  tax  equivalent  to 
ten  per  centum  of  the  amount  paid  for  seats,  berths,  and  staterooms  in  parlor 
cars,  sleeping  cars,  or  on  vessels.  If  a  mileage  book  used  for  such  transporta- 
tion or  accommodation  has  been  purchased  before  this  section  takes  effect,  or 
if  cash  fare  be  paid,  the  tax  imposed  by  this  section  shall  be  collected  from  the 
person  presenting  the  mileage  book,  or  paying  the  cash  fare,  by  the  conductor 
or  other  agent,  when  presented  for  such  transportation  or  accommodation,  and 
the  amount  so  collected  shall  be  paid  to  the  United  States  in  such  manner  and 
at  such  times  as  the  Commissioner  of  Internal  Revenue,  with  the  approval  of 
the  Secretary  of  the  Treasury,  may  prescribe;  if  a  ticket  (other  than  a  mileage 
book)  is  bought  and  partially  used  before  this  section  goes  into  effect  it  shall 
not  be  taxed,  but  if  bought  but  not  so  used  before  this  section  takes  effect,  it 
shall  not  be  valid  for  passage  until  the  tax  has  been  paid  and  such  payment 
evidenced  on  the  ticket  in  such  manner  as  the  Commissioner  of  Internal  Rev- 
enue, with  the  approval  of  the  Secretary  of  the  Treasury,  may  by  regulation 
prescribe;  (d)  a  tax  equivalent  to  a  five  per  centum  of  the  amount  paid  for  the 
transportation  of  oil  by  pipe  line;  (e)  a  tax  of  5  cents  upon  each  telegraph,  tele- 
phone, or  radio,  dispatch,  message,  or  conversation,  which  originates  within  the 
United  States,  and  for  the  transmission  of  which  a  charge  of  15  cents  or  more 
is  imposed:  Provided,  That  only  one  payment  of  such  tax  shall  be  required,  not- 
withstanding the  lines  or  stations  of  one  or  more  persons,  corporations,  part- 
nerships, or  associations  shall  be  used  for  the  transmission  of  such  dispatch, 
message,  or  conversation. 

PAID   BY   PATRONS. 

Sec.  501.  That  the  taxes  imposed  by  section  five  hundred  shall  be  paid  by 
the  person,  corporation,  partnership,  or  association  paying  for  the  services  or 
facilities  rendered. 

In  case  such  carrier  does  not,  because  of  its  ownership  of  the  commodity 
transported,  or  for  any  other  reason,  receive  the  amount  which  as  a  carrier  it 
would  otherwise  charge,  such  carrier  shall  pay  a  tax  equivalent  to  the  tax 
which  would  be  imposed  upon  the  transportation  of  such  commodity  if  the 
carrier  received  payment  for  such  transportation:  Provided,  That  in  case  of  a 
carrier  which  on  May  first,  nineteen  hundred  and  seventeen,  had  no  rates  or 
tariffs  on  file  with  the  proper  Federal  or  State  authority,  the  tax  shall  be  com- 
puted on  the  basis  of  the  rates  or  tariffs  of  other  carriers  for  like  services  as 
ascertained  and  determined  by  the  Commissioner  of  Internal  Revenue:  Provid- 
ed further,  That  nothing  in  this  or  the  preceding  section  shall  be  construed  as 
imposing  a  tax  (a)  upon  the  transportation  of  any  commodity  which  is  neces- 
sary for  the  use  of  the  carrier  in  the  conduct  of  its  business  as  such  and  is  in- 
tended to  be  so  used  or  has  been  so  used;  or  (b)  upon  the  transportation  of 
company  material  transported  by  one  carrier,  which  constitutes  a  part  of  a  rail- 
road system,  for  another  carrier  which  is  also  a  part  of  the  same  system. 

Sec.  502.  That  no  tax  shall  be  imposed  under  section  five  hundred  upon 
any  payment  received  for  services  rendered  to  the  United  States,  or  any  State, 
Territory,  or  the  District  of  Columbia.  The  right  to  exemption  under  this  sec- 
tion shall  be  evidenced  in  such  manner  as  the  Commissioner  of  Internal  Rev- 


APPENDIX— TEXT    OF    LAW  39 

enue,  with  the  approval  of  the  Secretary  of   the    Treasury,  may  by  regulation 
prescribe. 

MONTHLY  RETURN  AND  PAYMENT. 

Sec.503.  That  each  person,  corporation,  partnership,  or  association  receiv- 
ing any  payments  referred  to  in  section  five  hundred  shall  collect  the  amount  of 
the  tax,  if  any,  imposed  by  such  section  from  the  person,  corporation,  partner- 
ship, or  association  making  such  payments,  and  shall  make  monthly  returns 
under  oath,  in  duplicate,  and  pay  the  taxes  so  collected  and  the  taxes  imposed 
upon  it  under  paragraph  two  of  section  five  hundred  and  one  to  the  collector  of 
internal  revenue  of  the  district  in  which  the  principal  office  or  place  of  business 
is  located.  Such  returns  shall  contain  such  information,  and  be  made  in  such 
manner,  as  the  Commissioner  of  Internal  Revenue,  with  the  approval  of  the 
Secretary  of  the  Treasury,  may  by  regulation  prescribe. 

ON    INSURANCE    POLICIES. 

Sec.  504.  That  from  and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected,  and  paid  the  following 
taxes  on  the  issuance  of  insurance  policies: 

LIFE   INSURANCE. 

(a)  Life  insurance:  A  tax  equivalent  to  8  cents  on  each  $100  or  fractional 
part  thereof  of  the  amount  for  which  any  life  is  insured  under  any  policy  of  in- 
surance, or  other  instrument,  by  Whatever  name  the  same  is  called:   Provided, 
That  on  all  policies  for  life  insurance  only  by  which  a  life  is  insured  not  in  ex- 
cess of  $500,  issued  on  the  industrial  or  weekly  payment  plan  of  insurance,  the 
tax  shall  be  forty  per  centum  of  the  amount  of  the  first  weekly  premium:  Pro- 
vided further,  That  policies  of  reinsurance  shall  be  exempt  from    the    tax  im- 
posed by  this  subdivision; 

MARINE,   INLAND   AND   FIRE    INSURANCE. 

(b)  Marine,  inland,  and  fire  insurance:   A  tax  equivalent  to  1  cent  on  each 
dollar  or  fractional  part  thereof  of  the  premium  charged  under  each  policy  of 
insurance  or  other  instrument  by  whatever  name  the  same  is  called  whereby 
insurance  is  made  or  renewed    upon    property    of    any    description    (including 
rents  or  profits),  whether  against  peril  by  sea  or  inland  waters,  or   by   fire   or 
lightning,  or  other  peril:   Provided,  That  policies  of  reinsurance  shall  be  exempt 
from  the  tax  imposed  by  this  subdivision. 

CASUALTY  INSURANCE. 

(c)  Casualty  insurance:  A  tax  equivalent  to  1  cent  on  each  dollar  or  frac- 
tional part  thereof  of  the  premium  charged  under  each  policy  of  insurance  or 
obligation  of  the  nature  of  indemnity   for   loss,   damage,   or   liability    (except 
bonds  taxable  under  subdivision  two  of  schedule  A  of  Title  VIII)  issued  or  exe- 
cuted or  renewed  by  any  person,  corporation,  partnership,  or  association,  trans- 
acting the  business  of  employer's  liability,  workmen's  compensation,  accident, 
health,  tornado,  plate  glass,  steam  boiler,  elevator,  burglary,  automatic  sprink- 
ler, automobile,  or  other  branch  of  insurance  (except  life  insurance,  and  insur- 
ance described  and  taxed  in  the  preceding  subdivision) :   Provided,  That  poli- 
cies of  reinsurance  shall  be  exempt  from  the  tax  imposed  by  this  subdivision; 

THOSE   EXEMPT. 

(d)  Policies  issued  by  any  person,  corporation,  partnership,  or  association, 
whose  income  is  exempt  from  taxation  under  Title  I  of   the  Act  entitled    "An 
Act  to  increase  the  revenue,   and   for   other   purposes,"    approved    September 
eighth,  nineteen  hundred  and  sixteen,  shall  be  exempt  from  the  taxes  imposed 
by  this  section. 

MONTHLY  RETURN  AND  PAYMENT. 

Sec.  505.  That  every  person,  corporation,  partnership,  or  association,  issu- 
ing policies  of  insurance  upon  the  issuance  of  which  a  tax  is  imposed  by  sec- 
tion five  hundred  and  four,  shall,  within  the  first  fifteen  days  of  -each  month, 


40  APPENDIX— TEXT    OF    LA\\ 

make  a  return  under  oath,  in  duplicate,  and  pay  such  tax  to  the  collector  of  in- 
ternal revenue  of  the  district  in  which  the  principal  office  or  place  of  business 
of  such  person,  corporation,  partnership,  or  association  is  located.  Such  re- 
turns shall  contain  such  information  and  be  made  in  such  manner  as  the  Com- 
missioner of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the  Treas- 
ury, may  by  regulation  prescribe. 


THE  WAR  EXCISE  TAXES 

On 

MOTOR  VEHICLES,  MUSICAL  INSTRUMENTS,  PICTURE 

FILMS,    JEWELRY,    SPORTING    GOODS,    TOILET 

ARTICLES,   PATENT   MEDICINES,   CAMERAS, 

CHEWING  GUM  AND  BOATS. 


Title  VI  of  the  Act  of  October  3,  1917. 


AUTOMOBILES. 

That  there  shall  be  levied,  assessed,  collected,  and  paid — 

(a)  Upon    all    automobiles,    automobile    trucks,    automobile    wagons,    and 
motorcycles,  sold  by  the  manufacturer,  producer,  or  importer,  a  tax  equivalent 
to  three  per  centum  of  the  price  for  which  so  sold;  and 

MUSICAL   INSTRUMENTS. 

(b)  Upon  all  piano  players,  graphophones,  phonographs,  talking  machines, 
and  records  used  in  connection    with    any    musical    instrument,    piano    player, 
graphophone,  phonograph,  or  talking  machine,  sold  by  the  manufacturer,  pro- 
ducer, or  importer,  a  tax  equivalent  to  three  per  centum  of  the  price  for  which, 
so  sold;  and 

MOVING   PICTURE   FILMS. 

(c)  Upon  all  moving-picture  films  (which  have  not  been  exposed)  sold  by 
the  manufacturer  or  importer,  a  tax  equivalent    to    one-fourth    of    1    cent   per 
linear  foot;  and 

(d)  Upon  all  positive  moving-picture  films  (containing  a  picture  ready  for 
projection)  sold  or  leased  by  the  manufacturer,  producer,  or  importer,    a    tax 
equivalent  to  one-half  of  1  cent  per  linear  foot;  and 

JEWELRY. 

(e)  Upon    any    article    commonly    or    commercially    known    as    jewelry, 
whether   real    or    imitation,    sold    by    the   manufacturer,  producer,  or  importer 
thereof,  a  tax  equivalent  to  three  per  centum  of  the  price    for   which  so  sold; 
and 

SPORTING  GOODS. 

(f)  Upon  all  tennis  rackets,  golf  clubs,  baseball  bats,  lacrosse  sticks,  balls 
of  all  kinds,  including  baseballs,  foot  balls,  tennis,  golf,  lacrosse,  billiard  and 
pool  balls,  fishing  rods  and  reels,  billiard    and    pool  tables,  chess  and  checker 
boards  and  pieces,  dice,  games  and  parts  of  games,  except  playing  cards  and 
children's  toys  and  games,  sold  by  the  manufacturer,  producer  or  importer,  a 
tax  equivalent  to  three  per  centum  of  the  price  for  which  so  sold;  and 


APPENDIX— TEXT  OF  LAW  4i 

TOILET  ARTICLES. 

(g)  Upon  all  perfumes,  essences,  extracts,  toilet  waters,  cosmetics,  petro- 
leum jellies,  hair  oils,  pomades,  hair  dressings,  hair  restoratives,  hair  dyes, 
tooth  and  mouth  washes,  dentrifrices,  tooth  pastes,  aromatic  cachous,  toilet 
soaps  and  powders,  or  any  similar  substance,  article,  or  preparation  by  whatso- 
ever name  known  or  distinguished,  upon  all  of  the  above  which  are  used  or  ap- 
plied or  intended  to  be  used  or  applied  for  toilet  purposes,  and  which  are  sold 
by  the  manufacturer,  importer,  or  producer,  a  tax  equivalent  to  two  per  centum 
of  the  price  for  which  so  sold;  and 

PATENT    MEDICINES. 

(h)  Upon  all  pills,  tablets,  powders,  tinctures,  troches  or  lozenges,  sirups, 
medicinal  cordials  or  bitters,  anodynes,  tonics,  plasters,  liniments,  salves,  oint- 
ments, pastes,  drops,  waters  (except  those  taxed  under  section  three  hundred 
and  thirteen  of  this  Act),  essences,  spirits,  oils,  and  all  medicinal  preparations, 
compounds,  or  compositions  whatsoever,  the  manufacturer  or  producer  of  which 
claims  to  have  any  private  formula,  secret,  or  occult  art  for  making  or  prepar- 
ing the  same,  or  has  or  claims  to  have  any  exclusive  right  or  title  to  the  mak- 
ing or  preparing  the  same,  or  which  are  prepared,  uttered,  vended,  or  exposed 
for  sale  under  any  letters  patent,  or  trade-mark,  or  which,  if  prepared  by  any 
formula,  published  or  unpublished,  are  held  out  or  recommended  to  the  public 
by  the  makers,  venders,  or  proprietors  thereof  as  proprietary  medicines  or 
medicinal  proprietary  articles  or  preparations,  or  as  remedies  or  specifics  for 
any  disease,  diseases,  or  affection  whatever  affecting  the  human  or  animal 
body,  and  which  are  sold  by  the  manufacturer,  producer,  or  importer,  a  tax 
equivalent  to  two  per  centum  of  the  price  for  which  so  sold;  and 

CHEWING  GUM. 

(i)  Upon  all  chewing  gum  or  substitute  therefor  sold  by  the  manufacturer, 
producer,  or  importer,  a  tax  equivalent  to  two  per  centum  of  the  price  for  which 
so  sold;  and 

CAMERAS. 

(j)  Upon  all  cameras  sold  by  the  manufacturer,  producer,  or  importer,  a 
tax  equivalent  to  three  per  centum  of  the  price  for  which  so  sold. 

MONTHLY  RETURN  AND  PAYMENT. 

Sec.  601.  That  each  manufacturer,  producer,  or  importer  of  any  of  the 
articles  enumerated  in  section  six  hundred  shall  make  monthly  returns  under 
oath  in  duplicate  and  pay  the  taxes  imposed  on  such  articles  by  this  title  to  the 
collector  of  internal  revenue  for  the  district  in  which  is  located  the  principal 
place  of  business.  Such  returns  shall  contain  such  information  and  be  made 
at  such  times  and  in  such  manner  as  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  may  by  regulations  pre- 
scribe. 

ARTICLES   ON    HAND. 

Sec.  602.  That  upon  all  articles  enumerated  in  subdivisions  (a),  (b),  (-a), 
(f),  (g)>  (h)>  U)>  or  (j)  of  section  six  hundred,  which  on  the  day  this  Act  is 
passed  are  held  and  intended  for  sale  by  any  person,  corporation,  partnership, 
or  association,  other  than  (1)  a  retailer  who  is  not  also  a  wholesaler,  or  (2)  the 
manufacturer,  producer,  or  importer  thereof,  there  shall  be  levied,  assessed, 
collected,  and  paid,  a  tax  equivalent  to  one-half  the  tax  imposed  by  each  such 
subdivision  upon  the  sale  of  the  articles  therein  enumerated.  This  tax  shall  be 
paid  by  the  person,  corporation,  partnership,  or  association  so  holding  such 
articles. 

The  taxes  imposed  by  this  section  shall  be  assessed,  collected,  and  paid  in 
the  same  manner  as  provided  in  section  ten  hundred  and  two  in  the  case  of 
additional  taxes  upon  articles  upon  which  the  tax  imposed  by  existing  law  has 
been  paid. 

Nothing  in  this  section  shall  be  construed  to  impose  a  tax  upon  articles 
sold  and  delivered  prior  to  May  ninth,  nineteen  hundred  and  seventeen,  where 
the  title  is  reserved  in  the  vendor  as  security  for  the  payment  of  the  purchase 
money. 


42  APPENDIX— TEXT    OF    LAW 

YACHTS  AND  PLEASURE  BOATS. 

Sec.  603.  That  on  the  day  this  Act  takes  effect,  and  thereafter  on  July  first 
in  each  year,  and  also  at  the  time  of  the  original  purchase  of  a  new  boat  by  a 
user,  if  on  any  other  date  than  July  first,  there  shall  be  levied,  assessed,  col- 
lected, and  paid,  upon  the  use  of  yachts,  pleasure  boats,  power  boats,  and  sail- 
ing boats,  of  over  five  net  tons,  and  motor  boats  with  fixed  engines,  not  used 
exclusively  for  trade  or  national  defense,  or  not  built  according  to  plans  and 
specifications  approved  by  the  Navy  Department,  an  excise  tax  to  be  based  on 
each  yacht  or  boat,  at  rates  as  follows:  Yachts,  pleasure  boats,  power  boats, 
motor  boats  with  fixed  engines,  and  sailing  boats,  of  over  five  net  tons,  length 
not  over  fifty  feet,  50  cents  for  each  foot,  length  over  fifty  feet  and  not  over  one 
hundred  feet,  $1  for  each  foot,  length  over  one  hundred  feet,  $2  for  each  foot; 
motor  boats  of  not  over  five  net  tons  with  fixed  engines,  $5. 

In  determining  the  length  of  such  yachts,  pleasure  boats,  power  boats, 
motor  boats  with  fixed  engines,  and  sailing  boats,  the  measurement  of  over-all 
length  shall  govern. 

In  the  case  of  a  tax  imposed  at  the  time  of  the  original  purchase  of  a  new 
boat  on  any  other  date  than  July  first,  the  amount  to  be  paid  shall  be  the  same 
number  of  twelfths  of  the  amount  of  the  tax  as  the  number  of  calendar  months, 
including  the  month  of  sale,  remaining  prior  to  the  following  July  first. 


THE  WAR  TAX  ON 
ADMISSIONS  AND  DUES. 


Title  VII  of  the  Act  of  October  3,  1917. 


ADMISSIONS  TO  THEATRES,  ETC. 

Sec.  700.  That  from  and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected,  and  paid  (a)  a  tax  of 
1  cent  for  each  10  cents  or  fraction  thereof  of  the  amount  paid  for  admission 
to  any  place,  including  admission  by  season  ticket  or  subscription,  to  be  paid 
by  the  person  paying  for  such  admission:  Provided,  That  the  tax  on  admission 
of  children  under  twelve  years  of  age  where  an  admission  charge  for  such 
children  is  made  shall  in  every  case  be  1  cent;  and  (b)  in  the  case  of  persons 
(except  bona  fide  employees,  municipal  officers  on  official  business,  and  chil- 
dren under  twelve  years  of  age)  admitted  free  to  any  place  at  a  time  when  and 
under  circumstances  under  which  an  admission  charge  is  made  to  other  per- 
sons of  the  same  class,  a  tax  of  1  cent  for  each  10  cents  or  fraction  thereof  of 
the  price  so  charged  to  such  other  persons  for  the  same  or  similar  accommoda- 
tions, to  be  paid  by  the  persons  so  admitted;  and  (c)  a  tax  of  1  cent  for  each 
10  cents  or  fraction  thereof  paid  for  admission  to  any  public  performance  for 
profit  at  any  cabaret  or  other  similar  entertainment  to  which  the  charge  for 
admission  is  wholly  or  in  part  included  in  the  price  paid  for  refreshment,  ser- 
vice, or  merchandise;  the  amount  paid  for  such  admission  to  be  computed 
under  rules  prescribed  by  the  Commissioner  of  Internal  Revenue,  with  the  ap- 
proval of  the  Secretary  of  the  Treasury,  such  tax  to  be  paid  by  the  person  pay- 
ing for  such  refreshment,  service,  or  merchandise.  In  the  case  of  persons  hav- 
ing the  permanent  use  of  boxes  or  seats  in  an  opera  house  or  any  place  of 
amusement  or  a  lease  for  the  use  of  such  box  or  seat  in  such  opera  house  or 
place  of  amusement  there  shall  be  levied,  assessed,  collected,  and  paid  a  tax 
equivalent  to  ten  per  centum  of  the  amount  for  which  a  similar  box  or  seat  is 
sold  for  performance  or  exhibition  at  which  the  box  is  used  or  reserved  by  or 


APPENDIX— TEXT    OF    LAW  43 

for  the  lessee  or  holder.  These  taxes  shall  not  be  imposed  in  the  case  of  a 
place  the  maximum  charge  for  admission  to  which  is  5  cents,  or  in  the  case  of 
shows,  rides,  and  other  amusements,  (the  maximum  charge  for  admission  to 
which  is  10  cents)  within  outdoor  general  amusement  parks,  or  in  the  case  of 
admissions  to  such  parks. 

No  tax  shall  be  levied  under  this  title  in  respect  to  any  admissions  all  the 
proceeds  of  which  inure  exclusively  to  the  benefit  of  religious,  educational,  or 
charitable  institutions,  societies,  or  organizations,  or  admissions  to  agricul- 
tural fairs,  none  of  the  profits  of  which  are  distributed  to  stockholders  or  mem- 
bers of  the  association  conducting  the  same. 

The  term  "admission"  as  used  in  this  title  includes  seats  and  tables,  re- 
served or  otherwise,  and  other  similar  accommodations,  and  the  charges  made 
therefor. 

CLUB  DUES. 

Sec.  701.  That  from  and  after  the  first  day  of  November,  nineteen  hundred 
and  seventeen,  there  shall  be  levied,  assessed,  collected,  and  paid,  a  tax  equi- 
valent to  ten  per  centum  of  any  amount  paid  as  dues  or  membership  fees  (in- 
cluding initiation  fees),  to  any  social,  athletic,  or  sporting  club  or  organization, 
where  such  dues  or  fees  are  in  excess  of  $12  per  year;  such  taxes  to  be  paid  by 
the  person  paying  such  dues  or  fees:  Provided,  That  there  shall  be  exempted 
from  the  provisions  of  this  section  all  amounts  paid  as  dues  or  fees  to  a  frater- 
nal beneficiary  society,  order,  or  association,  operating  under  the  lodge  system 
or  for  the  exclusive  benefit  of  the  members  of  a  fraternity  itself  operating 
under  the  lodge  system,  and  providing  for  the  payment  of  life,  sick,  accident, 
or  other  benefits  to  the  members  of  such  society,  order,  or  association  or  their 
dependents. 

MONTHLY   RETURN    AND   PAYMENT. 

Sec.  702.  That  every  person,  corporation,  partnership,  or  association  (a) 
receiving  any  payments  for  such  admission,  dues,  or  fees,  shall  collect  the 
amount  of  the  tax  imposed  by  section  seven  hundred  or  seven  hundred  and  one 
from  the  person  making  such  payments,  or  (b)  admitting  any  person  free  to 
any  place  for  admission  to  which  a  charge  is  made  shall  collect  the  amount  of 
the  tax  imposed  by  section  seven  hundred  from  the  person  so  admitted,  and 
(c)  in  either  case  shall  make  returns  and  payments  of  the  amounts  so  collect- 
ed, at  the  same  time  and  in  the  same  manner  as  provided  in  section  five  hun- 
dred and  three  of  this  Act. 


THE  WAR  STAMP  TAXES 


Title  VIII  of  the  Act  of  October  3,  1917. 


DOCUMENTS  AND  ARTICLES. 

Sec.  800.  That  on  and  after  the  first  day  of  December,  nineteen  hundred 
and  seventeen  there  shall  be  levied,  collected,  and  paid,  for  and  in  respect  of 
the  several  bonds,  debentures,  or  certificates  of  stock  and  of  indebtedness,  and 
other  documents,  instruments,  matters,  and  things  mentioned  and  described  in 
Schedule  A  of  this  title,  or  for  or  in  respect  of  the  vellum,  parchment,  or  paper 
upon  which  such  instruments,  matters,  or  things,  or  any  of  them,  are  written 
or  printed,  by  any  person,  corporation,  partnership,  or  association  who  makes, 
signs,  issues,  sells,  removes,  consigns,  or  ships  the  same,  or  for  whose  use  or 
benefit  the  same  are  made,  signed,  issued,  sold,  removed,  consigned,  or  shipped, 
the  several  taxes  specified  in  such  schedule. 


44  APPENDIX— TEXT    OF    LAW 

NOT  SUBJECT  TO  TAX. 

Sec.  801.  That  there  shall  not  be  taxed  under  this  title  any  bond,  note,  or 
other  instrument,  issued  by  the  United  States,  or  by  any  foreign  Government, 
or  by  any  State,  Territory,  or  the  District  of  Columbia,  or  local  subdivision 
thereof,  or  municipal  or  other  corporation  exercising  the  taxing  power,  when 
issued  in  the  exercise  of  a  strictly  governmental,  taxing,  or  municipal  function; 
or  stocks  and  bonds  issued  by  cooperative  building  and  loan  associations  which 
are  organized  and  operated  exclusively  for  the  benefit  of  their  members  and 
make  loans  only  to  their  shareholders,  or  by  mutual  ditch  or  irrigating  com- 
panies. 

PENALTY   FOR   VIOLATION. 

That  whoever — 

(a)  Makes,  signs,  issues,  or  accepts,  or  causes  to  be  made,  signed,  issued, 
or  accepted,  any  instrument,  document,  or  paper  of    any    kind    or    description 
whatsoever  without  the  full  amount  of  tax  thereon  being  duly  paid; 

(b)  Consigns  or  ships,  or  causes  to  be  consigned  or  shipped,  by  parcel  post 
any  parcel,  package,  or  article  without  the  full  amount  of  tax  being  duly  paid ; 

(c)  Manufactures  or  imports  and  sells,  or  offers  for  sale,  or  causes  to  be 
manufactured  or  imported  and    sold,    or    offered    for    sale,   any   playing    cards, 
package,  or  other  article  without  the  full  amount  of  tax  being  duly  paid; 

(d)  Makes  use  of  an  adhesive  stamp  to  denote    any    tax    imposed    by  this 
title  without  canceling  or  obliterating    such    stamp    as    prescribed    in    section 
eight  hundred  and  four; 

Is  guilty  of  a  misdemeanor  and  upon  conviction  thereof  shall  pay  a  fine  of 
not  more  than  $100  for  each  effense. 

Sec.  803.  That  whoever — fraudulently  cuts,  tears,  or  removes  from  any  vel- 
lum, parchment,  paper,  instrument,  writing,  package,  or  article,  upon  which  any 
tax  is  imposed  by  this  title,  any  adhesive  stamp  or  the  impression  of  any  stamp, 
die,  plate,  or  other  article  provided,  made,  or  used  in  pursuance  of  this  title; 
(b)  Fraudulently  uses,  joins,  fixes,  or  places  to,  with,  or  upon  any  vellum, 
parchment,  paper,  instrument,  writing,  package,  or  article,  upon  which  any  tax 
is  imposed  by  this  title,  (1)  any  adhesive  stamp,  or  the  impression  of  any 
stamp,  die,  plate,  or  other  article,  which  has  been  cut,  torn,  or  removed  from 
any  other  vellum,  parchment,  paper,  instrument,  writing,  package,  or  article, 
upon  which  any  tax  is  imposed  by  this  title  or  (2)  any  adhesive  stamp  or  the 
impression  of  any  stamp,  die,  plate,  or  other  article  of  insufficient  value;  or  (3) 
any  forged  or  counterfeit  stamp,  or  the  impression  of  any  forged  or  counter- 
feited stamp,  die,  plate,  or  other  article; 

(c)  Willfully  removes,  or  alters  the  cancellation,  or  defacing  marks  of,  or 
otherwise  prepares,  any  adhesive  stamp,  with  intent  to  use,  or  cause  the  same 
to  be  used,  after  it  has  been  already  used,  or  knowingly  or  willfully  buys,  sells, 
offers  for  sale,  or  gives  away,  any  such  washed  or  restored  stamp  to  any  person 
for  use,  or  knowingly  uses  the  same; 

(d)  Knowingly  and  without  lawful  excuse  (the  burden  of  proof  of  such  ex- 
cuse being  on  the  accused)  has  in  possession  any  washed,  restored,  or  altered 
stamp,  which  has  been  removed    from    any    vellum,    parchment,  paper,  instru- 
ment, writing,  package,  or  article. 

Is  guilty  of  a  misdemeanor,  and  upon  conviction  shall  be  punished  by  a  fine 
of  not  more  than  $1,000,  or  by  imprisonment  for  not  more  than  five  years,  or 
both,  in  the  discretion  of  the  court,  and  any  such  reused,  canceled,  or  counter- 
feit stamp  and  the  vellum,  parchment,  document,  paper,  package,  or  article 
upon  which  it  is  placed  or  impressed  shall  be  forfeited  to  the  United  States. 

CANCELLATION    OF  STAMP. 

Sec.  804.  That  whenever  an  adhesive  stamp  is  used  for  denoting  any  tax 
imposed  by  this  title,  except  as  hereinafter  provided,  the  person,  corporation, 
partnership,  or  association,  using  or  affixing  the  same  shall  write  or  stamp  or 
cause  to  be  written  or  stamped  thereupon  the  initials  of  his  or  its  name  and 
the  date  upon  which  the  same  is  attached  or  used,  so  that  the  same  may  not 
again  be  used:  Provided,  That  the  Commissioner  of  Internal  Revenue  may 
prescribe  such  other  method  for  the  cancellation  of  such  stamps  as  he  may 
deem  expedient. 


APPENDIX— TEXT    OF    LAW  45 

Sec.  805.  (a)  That  the  Commissioner  of  Internal  Revenue  shall  cause  to  be 
prepared  and  distributed  for  the  payment  of  the  taxes  prescribed  in  this  title 
suitable  stamps  denoting  the  tax  on  the  document,  articles,  or  thing  to  which 
the  same  may  be  affixed,  and  shall  prescribe  such  method  for  the  affixing  of 
said  stamps  in  siiostitulion  for  or  in  addition  to  the  method  provided  in  this 
tirle  as  he  may  deem  expedient. 

(b)  The  Commissioner  of  Internal  Reveniu,  with  the  approval  of  the  Sec- 
retary of  the  Treasury,  is  authorized  to  procure  any  of  the  stamps  provided  for 
in  this  title  by  contract  whenever  such  stamps  can  not  be  speedily  prepared  by 
the  Bureau  of  Engraving  and  Printing;  but  this  authority  shall  expire  on  the 
first  day  of   January,  nineteen    hundred    and    eighteen,  except  as  to  imprinted 
stamps  furnished  under  contract,  authorized  by  the  Commissioner  of  Internal 
Revenue. 

(c)  All  internal-revenue  laws  relating  to  the  assessment  and  collection  of 
taxes  are  hereby  extended  to  and  made  a  part  of  this  title,  so  far  as  applicable, 
for  the  purpose  of  collecting  stamp    taxes    omitted    through   mistake   or   fraud 
from  any  instrument,  document,    paper,    writing,    parcel,    package,    or    article 
named  herein. 

SOLD   BY   POSTMASTERS. 

Sec.  806.  That  the  Commissioner  of  Internal  Revenue  shall  furnish  to  the 
Postmaster  General  without  prepayment  a  suitable  quantity  of  adhesive  stamps 
to  be  distributed  to  and  kept  on  sale  by  the  various  postmasters  in  the  United 
States.  The  Postmaster  General  may  require  each  such  postmaster  to  give 
additional  or  increased  bond  as  postmaster  for  the  value  of  the  stamps  so 
furnished,  and  each  such  postmaster  shall  deposit  the  receipts  from  the  sale  of 
such  stamps  to  the  credit  of  and  render  accounts  to  the  Postmaster  General  at 
such  times  and  in  such  form  as  he  may  by  regulations  prescribe.  The  Post- 
master General  shall  at  least  once  monthly  transfer  all  collections  from  this 
source  to  the  Treasury  as  internal-revenue  collections. 

SOLD  AT  U.  S.   DEPOSITORIES. 

Sec.  807.  That  the  collectors  of  the  several  districts  shall  furnish  without 
prepayment  to  any  assistant  treasurer  or  designated  depositary  of  the  United 
States  located  in  their  respective  collection  districts  a  suitable  quantity  of  ad- 
hesive stamps  for  sale.  In  such  cases  the  collector  may  require  a  bond,  with 
sufficient  sureties,  to  an  amount  equal  to  the  value  of  the  adhesive  stamps  so 
furnished,  conditioned  for  the  faithful  return,  whenever  so  required,  of  all 
quantities  or  amounts  undisposed  of,  and  for  the  payment  monthly  of  all  quan- 
tities or  amounts  sold  or  not  remaining  on  hand.  The  Secretary  of  the  Treas- 
ury may  from  time  to  time  make  such  regulations  as  he  may  find  necessary  to 
insure  the  safe-keeping  or  prevent  the  illegal  use  of  all  such  adhesive  stamps. 

SCHEDULE   A. — STAMP  TAXES. 

1.  Bonds  of  indebtedness:   Bonds,  debentures,  or  certificates  of  indebted- 
ness issued    on   and    after   the    first   day    of   December,  nineteen  hundred  and 
seventeen,  by  any  person,  corporation,  partnership,  or  association,  on  each  $100 
of  face  value  or  fraction  thereof,  5  cents:  Provided,  That  every  renewal  of  the 
foregoing  shall  be  taxed  as  a  new  issue:   Provided  further,  That  when  a  bond 
conditioned  for  the  repayment  or  payment  of  money  is  given  in  a  penal  sum 
greater  than  the  debt  secured,  the  tax  shall  be  based  upon  the  amount  secured. 

2.  Bonds,  Indemnity  and  Surety:   Bonds  for  indemnifying  any  person,  cor- 
poration, partnership,  or  corporation  who  shall  have  become  bound  or  engaged 
as  surety,  and  all  bonds  for  the  due  execution  or  performance  of  any  contract, 
obligation,  or  requirement,  or  the  duties  of  any  office  or  position,  and  to  account 
for  money  received  by  virtue  thereof,  and  all  other  bonds  of  any  description, 
except  such  as  may  be  required  in  legal  proceedings,  not  otherwise  provided  for 
in  this  schedule,  50  cents:   Provided,  That  where  a  premium  is  charged  for  the 
execution  of  such  bond  the  tax  shall  be  paid  at  the  rate  of  one  per  centum  on 
each  dollar  or  fractional  part  thereof  of  the  premium  charged:   Provided  fur- 
ther, That  policies  of  reinsurance  shall  be  exempt  from  the  tax  imposed  by  this 
subdivision. 


46  APPENDIX— TEXT    OF    LA\Y 

3.  Capital  stock,  issue:    On  each  original  issue,  whether  on  organization  or 
reorganization,  of  certificates  of  stock  by  any  association,  company,  or  corpora- 
tion, on  each  $100  of  face  value  or  fraction  thereof,  5  cents:    Provided,    That 
where  capital  stock  is  issued  without  face  value,  the  tax  shall  be  5  cents  per 
share,  unless  the  actual  value  is  in  excess  of  $100  per  share,  in  which  case  the 
tax  shall  be  5  cents  on  each  $100  of  actual  value  or  fraction  thereof. 

The  stamps  representing    the    tax    imposed    by    this    subdivision  shall  be 
attached  to  the  stock  books  and  not  to  the  certificates  issued. 

4.  Capital  stock,  sales  or  transfers:    On  all  sales,  or  agreements  to  sell,  or 
memoranda  of  sales  or  deliveries  of,  or  transfers    of   legal    title    to    shares   or 
certificates  of  stock  in  any  association,  company,  or  corporation,  whether  made 
upon  or  shown  by  the  books  of  the  association,  company,  or  corporation,  or  by 
any  assignment  in  blank,  or  by  any  delivery,  or  by  any  paper  or  agreement  or 
memorandum  or  other  evidence  of  transfer  or  sale,  whether  entitling  the  holder 
in  any  manner  to  the  benefit  of  such  stock  or  not,  on  each  $100  of  face  value  or 
fraction  thereof,  2  cents,  and  where  such  shares  of  stock  are  without  par  value, 
the  tax  shall  be  2  cents  on  the  transfer  or  sale  or  agreement  to  sell  on  each 
share,  unless  the  actual  value  thereof  is  in  excess  of  $100  per  share,  in  which 
case  the  tax  shall  be  2  cents  on  each  $100  of  actual  value  or  fraction  thereof: 
Provided.  That  it  is  not  intended  by  this  title  to  impose  a  tax  upon  an  agree- 
ment evidencing  a  deposit  of  stock  certificates  as  collateral  security  for  money 
loaned  thereon,  which  stock  certificates  are  not  actually  sold,  nor  upon  such 
stock  certificates  so  deposited:   Provided  further.  That  the  tax  shall  not  be  im- 
posed upon  deliveries  or  transfers  to  a  broker  for  sale,  nor  upon  deliveries  or 
transfers  by  a  broker  to  a  customer    for   whom  and  upon  whose  order  he  has 
purchased  same,  but  such  deliveries  or  transfers  shall  be  accompanied  by  a  cer- 
tificate setting  forth  the  facts:   Provided  further,  That  in  case  of  sale  where  the 
evidence  of  transfer  is  shown  only  by  the  books  of  the  company  the  stamp  shall 
be  placed  upon  such  books;  and  where  the  change  of  ownership  is  by  transfer  of 
the  certificate  the  stamp  shall  be  placed  upon  the  certificate;  and  in  cases  of  an 
agreement  to  sell  or  where  the  transfer  is  by  delivery  of  the  certificate  assigned 
in  blank  there  shall  be  made  and  delivered  by  the  seller  to  the  buyer  a  bill  or 
memorandum  of  such  sale,  to  which  the  stamp  shall  be  affixed;  and  every  bill 
or  memorandum  of  sale  or  agreement  to  sell  before  mentioned  shall  show  the 
date  thereof,  the  name  of  the  seller,  the  amount  of  the  sale,  and  the  matter  or 
thing  to  which  it  refers.     Any  person  or  persons  liable  to  pay  the  tax  as  herein 
provided,  or  anyone  who  acts  in  the  matter  as  agent  or  broker  for  such  person 
or  persons  who  shall  make  any  such    sale,    or    who    shall  in  pursuance  of  :my 
such  sale  deliver  any  stock  or  evidence  of  the  sale  of  any  stock  or  bill  or  mem- 
orandum thereof,  as  herein  required,  without  having  the  proper  stamps  affixed 
thereto  with  intent  to  evade  the  foregoing  provisions  shall  be  deemed  guilty 
of  a  misdemeanor,  and  upon  conviction  thereof  shall  pay  a  fine  of  not  exceeding 
$1.000,  or  be  imprisoned  not  more  than  six  months,  or  both,  at  the  discretion 
of  the  court. 

5.  Produce,  sales  of,  on  exchange:   Upon  each  sale,  agreement  of  sale,  or 
agreement  to  sell,  including  so-called  transferred  or  scratch  sales,  any  products 
or  merchandise  at  any  exchange,  or  board  of  trade,  or  other  similar  place,  for 
future  delivery,  for  each  $100  in  value  of  the  merchandise  covered  by  said  sale 
or  agreement  of  sale  or  agreement  to  sell.  2  cents,  and  for  each  additional  $100 
or  fractional  part  thereof  in  excess  of  $100,  2  cents:  Provided.    That    on    every 
sale  or  agreement  of  sale  or  agreement  to  sell  as  aforesaid  there  shall  be  made 
and  delivered  by  the  seller   to   the    buyer   a    bill,  memorandum,  agreement,  or 
other  evidence  of  such  sale,  agreement  of  sale,  or  agreement  to  sell,  to  which 
there  shall  be  affixed  a  lawful  stamp  or  stamps  in  value  equal  to  the  amount  of 
the  tax  on  such  sale:   Provided  further.  That  sellers  of  commodities  described 
herein,  having  paid  the  tax  provided  by  this  subdivision,  may  transfer  such  con- 
tracts to  a  clearing  house  corporation  or  association,  and  such  transfer  shall 
not  be  deemed  to  be  a  sale,  or  agreement  of  sale,  or  an  agreement  to  sell  within 
the  provisions  of  this  Act,  provided  that  such  transfer  shall  not  vest  any  bene- 
ficial interest  in  such  clearing  house  association  but  shall  be  made  for  the  sole 
purpose  of  enabling  such  clearing  house  association  to  adjust  and  balance  the 
accounts  of  the  members  of  said  clearing  house    association    on   their    several 
contracts.     And  every  such  bill,  memorandum,    or    other    evidence    of    sale    or 


APPENDIX— TEXT    OF    LAW  47 

agreement  to  sell  shall  show  the  date  thereof,  the  name  of  the  seller,  the 
amount  of  the  sale,  and  the  matter  or  thing  to  which  it  refers;  and  any  person 
or  persons  liable  to  pay  the  tax  as  herein  provided,  or  anyone  who  acts  in  the 
matter  as  agent  or  broker  for  such  person  or  persons,  who  shall  make  any  such 
sale  or  agreement  of  sale,  or  agreement  to  sell,  or  who  shall,  in  pursuance  of 
any  such  sale,  agreement  of  sale,  or  agreement  to  sell,  deliver  any  such  pro- 
ducts or  merchandise  without  a  bill,  memorandum,  or  other  evidence  thereof 
as  herein  required,  or  who  shall  deliver  such  bill,  memorandum,  or  other  evi- 
dence of  sale,  or  agreement  to  sell,  without  having  the  proper  stamps  affixed 
thereto,  with  intent  to  evade  the  foregoing  provisions,  shall  be  deemed  guilty 
of  a  misdemeanor,  and  upon  conviction  thereof  shall  pay  a  fine  of  not  exceed- 
ing $1,000.  or  be  imprisoned  not  more  than  six  months,  or  both,  at  the  discre- 
tion of  the  court. 

That  no  bill,  memorandum,  agreement,  or  other  evidence  of  such  sale,  or 
agreement  of  sale,  or  agreement  to  sell,  in  case  of  cash  sales  of  products  or 
merchandise  for  immediate  or  prompt  delivery  which  in  good  faith  are  actually 
intended  to  be  delivered  shall  be  subject  to  this  tax. 

6.  Drafts  or  checks  payable  otherwise  than  at  sight  or  on  demand,  promis- 
sory notes,  except  bank  notes  issued  for  circulation,  and  for  each  renewal  of 
the  same,  for  a  sum  not  exceeding  $100,  2  cents;  and  for  each  additional  $100 
or  fractional  part  thereof,  2  cents. 

I.  Conveyance:. .Deed,  instrument,    or    writing,    whereby    any    lands,    tene- 
ments, or  other  realty  sold  shall  be  granted,  assigned,  transferred,  or  otherwise 
conveyed  to,  or  vested  in,  the  purchaser  or  purchasers,  or  any  other  person  or 
persons,  by  his,  her,  or  their  direction,  when  the  consideration  or  value  of  the 
interest  or  property  conveyed,  exclusive  of  the  value    of   any    lien    or    encum- 
brance remaining  thereon  at  the  time  of  sale,  exceeds  $100  and  does  not  exceed 
$500,  50  cents;  and  for  each  additional  $500  or  fractional  part  thereof  50  cents: 
Provided.  That  nothing  contained  in  this  paragraph  shall  be  so  construed  as  to 
impose  a  tax  upon  any  instrument  or  writing  given  to  secure  a  debt. 

8.  Entry  of  any  goods,  wares,  or  merchandise  at  any  custom-house,  either 
for  consumption  or  warehousing,  not  exceeding  $100  in  value,  25  cents;  exceed- 
ing $100  and  not  exceeding  $500  in  value,  50  cents;  exceeding  $500  in  value,  $1. 

9.  Entry  for  the  withdrawal  of   any  goods    or    merchandise    from    customs 
bonded  warehouse,  50  cents. 

10.  Passage    ticket,    one  way  or  round  trip,  for  each  passenger,  sold  or  is- 
sued in  the  United  States  for  passage  by  any  vessel  to  a  port  or  place  not   in 
the  United  States,  Canada,  or  Mexico,  if  costing  not  exceeding  $30,  $1;  costing 
more  than  $30  and  not  exceeding  $60,  $3;  costing  more  than  $60,  $5:  Provided, 
That  such  passage  tickets,  costing  $10  or  less,  shall  be  exempt  from  taxation. 

II.  Proxy  for  voting  at  any  election  for  officers,  or  meeting  for  the  transac- 
tion of  business,  of  any  incorporated  company  or  association,  except  religious, 
educational,  charitable,  fraternal,  or  literary  societies,  or  public  cemeteries,  10 
cents. 

12.  Power  of  attorney  granting  authority  to  do  or  perform  some  act  for  or 
in  behalf  of  the  grantor,  which  authority  is  not  otherwise  vested  in  the  grantee, 
25  cents:   Provided,  That  no  stamps  shall  be  required  upon  any  papers  neces- 
sary to  be  used  for  the  collection  of  claims  from  the  United  States  or  from  any 
State  for  pensions,  back  pay,  bounty,  or  for  property   lost   in    the   military   or 
naval  service  or  upon  powers  of  attorney  required  in  bankruptcy  cases. 

13.  Playing  cards:   Upon  every  pack  of  playing  cards  containing  not  more 
than  fifty-four  cards,  manufactured  or  imported,  and  sold,  or  removed  for  con- 
sumption or  sale,  after  the  passage  of  this  Act.  a  tax  of   5    cents   per   pack   in 
addition  to  the  tax  imposed  under  existing  law. 

14.  Parcel-post  packages:   Upon  every  parcel  or  package  transported  from 
one  point  in  the  United  States  to  another  by  parcel  post  on  which  the  postage 
amounts  to  25  cents  or  more,  a  tax  of  1  cent  for  each  25  cents  or  fractional  part 
thereof  charged  for  such  transportation,  to  be  paid  by  the  consignor. 

No  such  parcel  or  package  shall  be  transported  until  a  stamp  or  stamps 
representing  the  tax  due  shall  have  bean  affixed  thereto. 


48  APPENDIX— TEXT    OF    LAW 

THE  WAR  ESTATE  TAX 


Title  IX  of  the  Act  of  October  3,  1917. 


Sec.  900.  That  in  addition  to  the  tax  imposed  by  section  two  hundred  and 
one  of  the  Act  entitled  "An  Act  to  increase  the  revenue,  and  for  other  pur- 
poses," approved  September  eighth,  nineteen  hundred  and  sixteen,  as 
amended — 

(a),  A  tax  equal  to  the  following  percentages  of  its  value  is  hereby  imposed 
upon  the  transfer  of  each  net  estate  of  every  decedent  dying  after  the  passage 
of  this  Act,  the  transfer  of  which  is  taxable  under  such  section  (the  value  of 
such  net  estate  to  be  determined  as  provided  in  Title  II  of  such  Act  of  Septem- 
ber eighth,  nineteen  hundred  and  sixteen) : 

One-half  of  one  per  centum  of  the  amount  of  such  net  estate  not  in  excess 
of  $50,000; 

One  per  centum  of  the  amount  by  which  such  net  estate  exceeds  $50,000 
and  does  not  exceed  $150,000; 

One  and  one-half  per  centum  of  the  amount  by  which  such  net  estate  ex- 
ceeds $150,000  and  does  not  exceed  $250,000; 

Two  per  centum  of  the  amount  by  which  such  net  estate  exceeds  $250,000 
and  does  not  exceed  $450,000; 

Two  and  one-half  per  centum  of  the  amount  by  which  such  net  estate  ex- 
ceeds $450,000  and  does  not  exceed  $1,000,000; 

Three  per  centum  of  the  amount  by  which  such  net  estate  exceeds 
$1,000,000  and  does  not  exceed  $2,000,000; 

Three  and  one-half  per  centum  of  the  amount  by  which  such  net  estate  ex- 
ceeds $2,000,000  and  does  not  exceed  $3,000,000; 

Four  per  centum  of  the  amount  by  which  such  net  estate  exceeds  $3,000,000 
and  does  not  exceed  $4,000,000; 

Four  and  one-half  per  centum  of  the  amount  by  which  such  net  estate  ex- 
ceeds $4,000,000  and  does  not  exceed  $5,000,000; 

Five  per  centum  of  the  amount  by  which  such  net  estate  exceeds  $5,000,000 
and  does  not  exceed  $8,000,000; 

Seven  per  centum  of  the  amount  by  which  such  net  estate  exceeds 
$8,000,000  and  does  not  exceed  $10,000,000;  and 

Ten  per  centum  of  the  amount  by  which  such  net  estate  exceeds 
$10,000,000. 

MILITARY  AND  NAVAL  EXEMPTION.   4 

Sec.  901.  That  the  tax  imposed  by  this  title  shall  not  apply  to  the  transfer 
of  the  net  estate  of  any  decedent  dying  while  serving  in  the  military  or  naval 
forces  of  the  United  States,  during  the  continuance  of  the  war  in  which  the 
United  States  is  now  engaged,  or  if  death  results  from  injuries  received  or 
disease  contracted  in  such  service,  within  one  year  after  the  termination  of 
such  war.  For  the  purposes  of  this  section  the  termination  of  the  war  shall  be 
evidenced  by  the  proclamation  of  the  President. 


ADMINISTRATIVE   AND   GENERAL 

PROVISIONS  OF  WAR 

REVENUE   ACT. 


Title  X  and  Title  XIII  of  the  Act  of  October  3,  1917. 


Sec.  1000.  That  there  shall  be    levied,  collected,    and    paid    in    the    United 
States,  upon  articles  coming  into  the  United  States  from  the  West  Indian  Is- 


APPENDIX— TEXT    OF    LAW  49 

lands  acquired  from  Denmark,  a  tax  equal  to  the  internal-revenue  tax  imposed 
in  the  United  States  upon  like  articles  of  domestic  manufacture;  such  articles 
shipped  from  said  islands  to  the  United  States  shall  be  exempt  from  the  pay- 
ment of  any  tax  imposed  by  the  internal-revenue  laws  of  said  islands:  Provid- 
ed, That  there  shall  be  levied,  collected,  and  paid  in  said  islands,  upon  articles 
imported  from  the  United  States,  a  tax  equal  to  the  internal-revenue  tax  im- 
posed in  said  islands  upon  like  articles  there  manufactured;  and  such  articles 
going  into  said  islands  from  the  United  States  shall  be  exempt  from  payment 
of  any  tax  imposed  by  the  internal-revenue  laws  of  the  United  States. 

Sec.  1001.  That  all  administrative,  special,  or  stamp  provisions  of  law,  in- 
cluding the  law  relating  to  the  assessment  of  taxes,  so  far  as  applicable,  are 
hereby  extended  to  and  made  a  part  of  this  Act,  and  every  person,  corporation, 
partnership,  or  association  liable  to  any  tax  imposed  by  this  Act,  or  for  the  col- 
lection thereof,  shall  keep  such  records  and  render,  under  oath,  such  state- 
ments and  returns,  and  shall  comply  with  such  regulations  as  the  Commissioner 
of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury,  may 
from  time  to  time  prescribe. 

Sec.  1002.  That  where  additional  taxes  are  imposed  by  this  Act  upon  ar- 
ticles or  commodities,  upon  which  the  tax  imposed  by  existing  law  has  been 
paid,  the  person,  corporation,  partnership,  or  association  required  by  this  Act 
to  pay  the  tax  shall,  within  thirty  days  after  its  passage,  make  return  under 
oath  in  such  form  and  under  such  regulations  as  the  Commissioner  of  Internal 
Revenue  with  the  approval  of  the  Secretary  of  the  Treasury  shall  prescribe. 

Payment  of  the  tax  shown  to  be  due  may  be  extended  to  a  date  not  exceed- 
ing seven  months  from  the  passage  of  this  Act,  upon  the  filing  of  a  bond  for 
payment  in  such  form  and  amount  and  with  such  sureties  as  the  Commissioner 
of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury,  may 
prescribe. 

Sec.  1003.  That  in  all  cases  where  the  method  of  collecting  the  tax  imposed 
by  this  Act  is  not  specifically  provided,  the  tax  shall  be  collected  in  such  man- 
ner as  the  Commissioner  of  Internal  Revenue  with  the  approval  of  the  Secre- 
tary of  the  Treasury  may  prescribe.  All  administrative  and  penalty  provisions 
of  Title  VIII  of  this  Act,  in  so  far  as  applicable,  shall  apply  to  the  collection  of 
any  tax  which  the  Commissioner  of  Internal  Revenue  determines  or  prescribes 
shall  be  paid  by  stamp. 

Sec.  1004.  That  whoever  fails  to  make  any  return  required  by  this  Act  or 
the  regulations  made  under  authority  thereof  within  the  time  prescribed  or 
who  makes  any  false  or  fraudulent  return,  and  whoever  evades  or  attempts  to 
evade  any  tax  imposed  by  this  Act  or  fails  to  collect  or  truly  to  account  for  and 
pay  over  any  such  tax,  shall  be  subject  to  a  penalty  of  not  more  than  $1,000,  or 
to  imprisonment  for  not  more  than  one  year,  or  both,  at  the  discretion  of  the 
court,  and  in  addition  theretc  a  penalty  of  double  the  tax  evaded,  or  not  collect- 
ed, or  accounted  for  and  pai  over,  to  be  assessed  and  collected  in  the  same 
manner  as  taxes  are  assessed  and  collected,  in  any  case  in  which  the  punish- 
ment is  not  otherwise  specifically  provided. 

Sec.  1005.  That  the  Commissioner  of  Internal  Revenue,  with  the  approval 
of  the  Secretary  of  the  Treasury,  is  hereby  authorized  to  make  all  needful  rules 
and  regulations  for  the  enforcement  of  the  provisions  of  this  Act. 

Sec.  1006.  That  where  the  rate  of  tax  imposed  by  this  Act,  payable  by 
stamps,  is  an  increase  over  previously  existing  rates,  stamps  on  hand  in  the 
collectors'  offices  and  in  the  Bureau  of  Internal  Revenue  may  continue  to  be 
used  until  the  supply  oh  hand  is  exhausted,  but  shall  be  sold  and  accounted  for 
at  the  rates  provided  by  this  Act,  and  assessment  shall  be  made  against  manu- 
facturers and  other  taxpayers  having  such  stamps  on  hand  on  the  day  this  Act 
takes  effect  for  the  difference  between  the  amount  paid  for  such  stamps  and  the 
tax  due  at  the  rates  provided  by  this  Act. 

Sec.  1007.  That  (a)  if  any  person,  corporation,  partnership,  or  association 
has  prior  to  May  ninth,  nineteen  hundred  and  seventeen,  made  a  bona  fide  con- 
tract with  a  dealer  for  the  sale,  after  the  tax  takes  effect,  of  any  article  (or,  in 
the  case  of  moving-picture  films,  such  a  contract  with  a  dealer,  exchange,  or 
exhibitor,  for  the  sale  or  lease  thereof)  upon  which  a  tax  is  imposed  under  Title 


50  APPENDIX— TEXT    OF    LAW 

III,  IV,  or  VI,  or  under  subdivision  thirteen  of  Schedule  A  of  Title  VIII,  or 
under  this  section,  and  (b)  if  such  contract  does  not  permit  the  adding  of  the 
whole  of  such  tax  to  the  amount  to  be  paid  under  such  contract,  then  the  ven- 
dee or  lessee  shall,  in  lieu  of  the  vendor  or  lessor,  pay  so  much  of  such  tax  as 
is  not  so  permitted  to  be  added  to  the  contract  price. 

The  taxes  payable  by  the  vendee  or  lessee  under  this  section  shall  be  paid 
to  the  vendor  or  lessor  at  the  time  the  sale  or  lease  is  consummated,  and  collect- 
ed, returned,  and  paid  to  the  United  States  by  such  vendor  or  lessor  in  the 
same  manner  as  provided  in  section  five  hundred  and  three. 

The  term  "dealer"  as  used  in  this  section  includes  a  vendee  who  purchases 
any  article  with  intent  to  use  it  in  the  manufacture  or  production  of  another 
article  intended  for  sale. 

Sec.  1008.  That  in  the  payment  of  any  tax  under  this  Act  not  payable  by 
stamp  a  fractional  part  of  a  cent  shall  be  disregarded  unless  it  amounts  to  one- 
half  cent  or  more,  in  which  case  it  shall  be  increased  to  one  cent. 

Sec.  1009.  That  the  Secretary  of  the  Treasury,  under  rules  and  regulations 
prescribed  by  him,  shall  permit  taxpayers  liable  to  income  and  excess  profits 
taxes  to  make  payments  in  advance  in  installments  or  in  whole  of  an  amount 
not  in  excess  of  the  estimated  taxes  which  will  be  due  from  them,  and  upon  de- 
termination of  the  taxes  actually  due  any  amount  paid  in  excess  shall  be  re- 
funded as  taxes  erroneously  collected:  Provided,  That  when  payment  is  made 
in  installments  at  least  one-fourth  of  such  estimated  tax  shall  be  paid  before 
the  expiration  of  thirty  days  after  the  close  of  the  taxable  year,  at  least  an 
additional  one-fourth  within  two  months  after  the  close  of  the  taxable  year,  at 
least  an  additional  one-fourth  within  four  months  after  the  close  of  the  taxable 
year,  and  the  remainder  of  the  tax  due  on  or  before  the  time  now  fixed  by  law 
for  such  payment:  Provided  further,  That  the  Secretary  of  the  Treasury,  under 
rules  and  regulations  prescribed  by  him,  may  allow  credit  against  such  taxes 
so  paid  in  advance  of  an  amount  not  exceeding  three  per  centum  per  annum  cal- 
culated upon  the  amount  so  paid  from  the  date  of  such  payment  to  the  date  now 
fixed  by  law  for  such  payment;  but  no  such  credit  shall  be  allowed  on  payments 
in  excess  of  taxes  determined  to  be  due,  nor  on  payments  made  after  the  expira- 
tion of  four  and  one-half  months  after  the  close  of  the  taxable  year.  All  penal- 
ties provided  by  existing  law  for  failure  to  pay  tax  when  due  are  hereby  made 
applicable  to  any  failure  to  pay  the  tax  at  the  time  or  times  required  in  this 
section. 

Sec.  1010.  That  under  rules  and  regulations  prescribed  by  the  Secretary  of 
the  Treasury,  Collectors  of  Internal  Revenue  may  receive,  at  par  and  accrued 
Interest,  certificates  of  indebtedness  issued  under  section  six  of  the  Act  entitled 
"An  Act  to  authorize  an  issue  of  bonds  to  meet  expenditures  for  the  national 
security  and  defense,  and,  for  the  purpose  of  assisting  in  the  prosecution  of  the 
war,  to  extend  credit  to  foreign  governments,  and  for  other  purposes,"  approved 
April  twenty-fourth,  nineteen  hundred  and  seventeen,  and  any  subsequent  Act 
or  Acts,  and  uncertified  checks  in  payment  of  income  and  excess  profits  taxes, 
during  such  time  and  under  such  regulations  as  the  Commissioner  of  Internal 
Revenue,  with  the  approval  of  the  Secretary  of  the  Treasury,  shall  prescribe; 
but  if  a  check  so  received  is  not  paid  by  the  bank  on  which  it  is  drawn  the  per- 
son by  whom  such  check  has  been  tendered  shall  remain  liable  for  the  payment 
of  the  tax  and  for  all  legal  penalties  and  additions  the  same  as  if  such  check 
had  not  been  tendered. 

Sec.  1300.  That  if  any  clause,  sentence,  paragraph,  or  part  of  this  Act  shall 
for  any  reason  be  adjudged  by  any  court  of  competent  jurisdiction  to  be  invalid, 
such  judgment  shall  not  affect,  impair,  or  invalidate  the  remainder  of  said  Act, 
but  shall  be  confined  in  its  operation  to  the  clause,  sentence,  paragraph,  or  part 
thereof  directly  involved  in  the  controversy  in  which  such  judgment  shall  have 
been  rendered. 

Sec.  1301.  That  Title  I  of  the  Act  entitled,  "An  Act  to  provide  increased 
revenue  to  defray  the  expenses  of  the  increased  appropriations  for  the  Army 
and  Navy  and  the  extension  of  fortifications,  and  for  other  purposes,"  approved 
March  third,  nineteen  hundred  and  seventeen,  be  and  the  same  is  hereby  re- 
pealed. 

Sec.  1302.  That  unless  otherwise  herein  specially  provided,  this  Act  shall 
take  effect  on  the  day  following  its  passage. 


INDEX 


INDEX 


INCOME  TAX 


Comment : 

Unless  otherwise   indicated  the  references  in  this  index  are  to 
paragraphs. 

References,  in  brackets,  to  the  text  of  the  law,  appearing  in  the 
Appendix,  are  by  Appendix  page  number  and  Law  Line  number. 


Abatement  of  assessments: 

Claims    for 373-374 

Absence: 

Extension  of  time  for  filing  returns 117 

Extension  of  time  for  paying  tax 360 

Return  made  by  agent 119 

Accident    Insurance 42-77-242 

Accounting,  no  fixed  method  prescribed 318 

Corporations    '.. 267-311-318 

Farmers  45-46-53-318 

Individuals    267-14-318-311 

Accounts    payable 318 

Accounts    receivable: 340 

Corporations    201-318-340 

Brokers  326 

Individuals    318-340 

Notes  in  payment 336 

Accumulation  of  gains  and  profits  of  corporation 174-308 

Additional  tax: 

Assessment  and  collection  of 352-353-354 

Including  dividends 104-306 

Corporations  not  subject  to 

Deduction  of  the  tax  at  the  source 307 

Dividends  to  be  included 104-306 

Husband  and  wife 303 

Non-resident   aliens 132 

Additions  and  betterments: 

Corporations    218 

Individuals  .: 72 

Investment  of  Depreciation  Reserve  in 279 


2  INDEX 

Administration  of  estates,  tax  liability  during  settlement 163-164-167-169 

Administrators  (See  "Fiduciaries") 
Agents: 

For  foreign  corporations 290 

For  non-resident  aliens 135 

Life  insurance;   commissions 20-21 

Paying  agents  appointed  at  the  source _ 153 

Real    estate 20-76-222 

Returns   by 119-290 

Withholding  agents  at  the  source .' 153 

Agricultural    organizations _ 190-191-195 

Aliens:    (non-resident  alien  individuals) Chap.  IX,  Page  66 

Additional  tax 132 

Agents  for 135 

American   wife 127 

Bad   debts 130 

Credits    allowed 131 

Deduction  of  tax  at  the  source 137-149 

Dividends  on  foreign  stock 138 

Exemption,    specific 128 

Exemption  at  source 149 

Expenses    deductible 130 

Income,  Returnable 125 

Interest   deductible 130 

Losses    deductible 130 

Losses  outside  of  business  or  trade 130 

Net   income 129 

Normal  tax 131-132 

Ownership  certificates 156 

Penalty  for  failure  to  make  return  and  pay  tax.... 133-365 

Permanent   improvements 

Real  Estate  agent  acting  for ...119 

Returns  by  non-resident  aliens ....133-134 

Returns  for  non-resident  aliens 135 

Specific    exemption .128 

Taxes  deductible 130 

Temporarily  living  within  the  United  States... ... 

Aliens    (resident)  —125 

Alimony    44 

Amended  returns  for  corporations ...122-321 

Amended  returns  for  individuals .....122-321 

Annuities,    exempt ....62-63 

Annual  list  returns  by  the  source: ...Chap.  XI,  Page  75 

Foreign    items 158 

Interest  on  domestic  obligations 148-149-150-153-154-1 5S 

Miscellaneous  income 158 

Appeals  to  Commissioner ....368-369-373 

Appreciation  in  value  of  capital  assets ....311 

Assessment  and  collection  of  tax   (Corporations): 

Bill  353 

Claims  for  refund  and  abatement 368  to  375 

Fiscal  year ......353 

Form  of  payment .  ..363 

Injunction  to  prevent  collection 

Notice  of  assessment 353 

Penalty  for  delay  in  paying.. 355-356 

Receipts  for  taxes  paid 364 

Suits   for  taxes 313-369-370-371 

Waiving  the  limitation 314 

When  assessment  is  made 352 

When  to  be  paid 354 


INDEX  3 

Assessment  and  collection  of  tax  (individuals) 

Bill  for  tax 353 

Claims  for  refund  and  abatement 368  to  375 

Extension  of  time 360 

Form  of  payment 363 

Injunction  to  prevent  collection ; 312 

Notice  of  assessment 353 

Penalty  for  delay  in  payment 355-356 

Except  from  estates  of  insane,  deceased,  or  insolvent  persons 359 

When  assessment  is  made 352 

When  tax  is  due 354 

Assessments  on   stock 74 

Bad    debts: 98-241 

Compromise  of  indebtedness 212 

Recoveries  on  bad  debts 200-206 

Bank  deposits:     interest  on • 32-261 

Banks: 

Depreciation  of  securities 275-311 

Dividends  on  Federal  Reserve  stock 200 

Federal  land 190 

Income  of.. '. 200 

Interest  paid  on  deposits  deductible 261 

Joint  stock  land 190 

Mutual   savings 190 

National  farm  loan , 190 

Private;   having  form  of  corporations 186 

Recoveries  of  bad  debts 200 

Taxes  paid  for  stockholders  on  stock 30-(Also  page  135) 

Bequests  are  exempt 62-64 

Betterments ' 72-218 

Bills  for   taxes '. 353 

Bills  of  exchange   (foreign) 158 

Bills  payable 318 

Bills    receivable 318-340 

Board  in  lieu  of  rent 24 

Boards  of  trade 190 

Bond,  fidelity :     premium  on 76 

Bond  for  collecting  foreign  items 158 

Bonded  indebtedness  of  corporations 212-245-246-(Also  pages  126  to  133 

Bonds:     interest  on  deducted  at  the  source 148  to  161 

Bonds  of  exempt  organizations 317 

Bonds:      retirement  of 212-246 

Bonds  sold  between  interest  dates 310 

Bonds:      tax-free   covenant 260-304 

Deduction  of  tax  at  the  source •. 148 

Taxes  paid  on  interest  on  are  not  deductible 260 

Bonds:     United  States,  State,  Municipal,  etc.  interest  is  exempt 62-65-66-297 

Partnerships  and  the  members  thereof..- 141 

Bonus: 

Gifts  not  subject  to  tax 62-64 

Taxable  under  certain  conditions ....16-225 

Book  values  and  entries: 

Appreciation  of  capital  assets 311 

Depreciation  of  capital  assets 311 

Depreciation   in  general 267 

Books;  examination  of  by  Government  officers 321 

Books:     no  prescribed  method  of  keeping 

Corporations 318 

Farmers    53 

Individuals  318 


4  INDEX 

Building  and  loan  associations  (domestic) 190-196 

Business    leagues 190 

Capital  Assets: 

Appreciation  of  not  evidenced  by  sale  or  other  disposition: 311 

Depreciation  of  not  evidenced  by  sale  or  other  disposition:... 311 

Loss  from  sale  of:....  ....89-90-93-94-95-96-97-239-240-247 

Capital  employed  in  business 251-252-253-256 

Capital  Stock: 

Assessments    on... 74 

Exchange    of 210-345 

Paid-up  capital  stock  in  determining  deductible  interest 251-254 

Preferred  stock  not  considered  interest-bearing  indebtedness 257 

Proceeds  from  sale  of 205 

Stock  without  par  value 252-256 

Voluntary  assessments  to  make  good  a  deficit 74 

Carrying  charges  in  connection  with  real  estate ....214-344 

Farmer   332 

Cases:   (See  Court  Decisions) Chap.  XXXVIII,  Page  300 

Cash  value  of  stock  dividends; ....25-27-338 

Cemetery    companies 190-197 

Certificates    ...156 

Certified  checks  in  payment  of  taxes ....363 

Chambers  of  commerce ...190 

Change  of  name  of  corporations 187 

Charitable  organizations: 

Exempt     : 190 

Gifts    to.... 101-227 

Citizenship  for  income  tax  purposes ....7-127 

Civic   leagues    (exempt) ....190 

Claims  for  deductions: 

Individuals  All  of  Chap.  VI.  Page  4°> 

Corporations  All  of  Chap.  XVI,  Page  116 

Non-resident   aliens 130-133 

Claims   for   exemption .4-105-378 

Claims  for  refund  and  abatement  of  taxes Chap.  XXIII,  Page  205 

Claim, — stays  5  per  cent  penalty ....331 

Clergymen's    offerings ....22 

Close    corporations ...183 

Clubs    190-198 

Collateral  subject  to  sale  or  hypothecation 258-235 

Collection  of  tax... 354  to  364 

Commissions:    ....20 

Real  estate  agents 20 — 222 

Renewal  premiums  on  insurance  policies ....21 

Salesmen 20-222 

Paid  in  stock ...  222 

Compromises 

Indebtedness     ..212 

Penalties    366 

Constitutionality  of  law (Court  Decisions) Page  301 

Contingent  Interests;  income  accumulated  in  trust 163-165-168-169 

Contracting    companies 201 

Co-operative  telephone  companies 190 

Corporations 

[APR.  P.  9  L.  L.  146-149] 
Accounting;   no  fixed  method 318 


INDEX  5 

Accumulation  of  gains  and  profits .'. ....174 

Additional  tax:    not  liable 173 

Assessment  and  collection  of  tax Chap!  XXI,  Page  196 

Banks  (See  "Banks") 

Bookkeeping;  no  special  system ; ....318 

Change  of  name !™."!l87 

Close    corporations ....183 

Compromises    ....366 

Deduction  of  the  tax  at  source 150-152 

Deductions  allowed All  of  Chap.  XVI,  Page  116 

Depletion  of  mines  and  wells All  of  Chap.  XVIII,  Page  149 

Depreciation  deductible All  of  Chap.  XVII,  Page  139 

Dividends  received  by  corporations 178-184-383-337 

[APR.  P.  25   L.   L.  40-43] 

Exempt  organizations All  of  Chap.  XIV,  Page  99 

[APP.  P.  11  L.  L.  158-172] 

Expenses  deductible 217  to  238,  also  329 

Fiscal    year 287 

Foreign    corporations 172-194-263-319-386-150 

Income;  gross All  of  Chap.  XV,  Page  104 

Income;    net 1-6 

Incompletely  organized 179 

Interest  deductible (Begin  Page  126)  then  248  to  261-also  343 

Lessee  and  lessor  corporations 216 

Liquidating  during  year 181-328 

Losses    deductible 

239  to  247,  also  327  and  all  of  Chapters  XVII  and  XVIII 

Officers:    Acknowledgments  to  returns 289 

Officers:    Penalties 365 

Operating   leased   properties 216 

Organized  during  year 180-287 

Part  of  year  corporations 180-181-328 

Partnerships  (All  of  Chap.  X,  Page  71)  Also  70-151-152-155 

Penalties    365 

Principal  place  of  business  of ..  290 

Returns Chap.  XIX,  Page  158  and  Chap.  XI,  Page  75 

Subsidiaries    90-337 

Tax    year 286 

Taxes   deductible Page   134 

Correction   of   returns 299-122 

Cost  of  property  in  connection  with  sales: 214-34-344-327-346 

Coupon  interest:  deduction  of  tax  at  the  source 148-149-154-155 

Coupon  interest:  information  at  source 158 

Credits  allowed: Page  300 

Dividends    104-383 

Excess  Profits  Tax 103 

Specific   exemption 105 

Tax  paid  at  source 108 

Damages:     43 

Death    during    year 170 

Debts    deductible 98-241 

Deceased  person;   170-359 

Decedent's  income  to  time  of  death;  . 170 

Deduction  of  tax  at  the  source: 

Amount  on  which  tax  is    deducted    is    a    credit   in    computing   normal 

tax     108-131 

Corporations 150-152 

Dividends  on  domestic  stock 150 

Foreign    governments , 320 

Interest  on  domestic  securities 148-149-150 

Non-resident  alien  individuals....  ....149-131 


6  INDEX 

Non-resident  alien  partnership ....151 

Non-resident  alien  corporations ....150 

Normal  tax  only 147 

Partnerships    , 151-152 

Deduction  of  tax  at  the  source  on  tax-free  securities 

Certificates  of  ownership ....156 

Citizens  or  residents  presenting  coupons  or  interest  orders....  ....148 

Exemption  claims 148-149-156 

Foreign  corporations  engaged  in  business  within  the  United  States    ....156 
Foreign    corporations    not    engaged    in  business    within    the    United 

States     150-156 

Foreign   partnerships ....151 

Non-resident   aliens 149-155-156 

Partnerships     ......151-152 

Paying   agents 153 

Penalties    365 

Returns:     monthly;  annual 155 

Tax-free  covenant  bonds 148-155 

Withholding    agents 153-155 

Deductions  allowed 

Citizens  or  residents Chap.  VI,  Page  43 

Corporations  Chap.  XVI,  Page  116 

Decedents    170-163 

Estates  during  settlement 164 

Estates  of  insolvent,  deceased  or  insane  persons 

Farmers    78 

Foreign   corporations ......... 

Non-resident   aliens -.'. 130 

Trust  estates  whose  income  is  not  distributed  annually ....165 

Delay  in  payment  of  tax;  penalty: 

Corporations , 

Individuals    ...355-356 

Depletion  of  mines ....280-281-284-285 

Depletion  of  oil  and  gas  wells ....280-281-282-283 

[APR.  P.  4  L.   L.  58-61] 
Depreciation 

Basis  of  Deduction 

Book  entries 267-311 

Definition   of 264 

Farmers    ....271-272-273 

Foreign    corporations 

Goodwill   

Livestock 272 

Non-resident    aliens 

No  fixed  percentages 268-269 

Patents    -----  -274 

Property  acquired  by  purchase  with  stock  of  corporation.... 

Real  Estate  and  Buildings 

Reserves  for 

Stocks  and  bonds..-. 

Trees   .. 

Vines   -  273 

Devises  are  exempt 

Dividends 

Additional  tax;  dividends  included •„...  ....26-104-306 

Corporations;  dividends  received.... 

Credited  for  normal  tax 

Deduction  of  tax  at  source ....150-155 

Federal  Reserve  Bank  Stock 

Foreign  Governments ;  dividends  paid  to  ... 

Foreign  corporations  engaged  in  business  within  the  United  States.. ..156 


INDEX  7 

Foreign  corporations  not  engaged  in  business  in  the  United  States.... 

150-155 

Income  for  year 25-26-27 

Life  Insurance :    Dividends 61 

Limited  Partnership  earnings 3X 

Non-resident  alien  individuals 131-138 

Record  owner  other  than  actual  owner 316 

Rental  payments;  dividends  as ....216 

Return  of:    included  in  annual  return 25-26 

Scrip    dividends 28 

Stock  dividends... 25-27-338 

Surplus,,  paid  from 339 

Taxes  paid  by  banks  for  stockholders 30 

Donations    101-227 

Educational   organizations,   exempt 190 

Educational   organizations,  donations  to 101 

Entertainment    expense 230 

Erroneous    returns 122-299-321 

Estates  during  settlement 

[APR.  P  2  L.  L.  31-35] 

Deductions   allowed : 163-164 

Liability  to  file  return 169 

Specific   exemption 168 

Estates,  trust:    undistributed  income  of 

Deductions   allowed 163-165-160 

Specific    exemption 168 

Examination   of   books    by   officers 321 

Exchange    rates 309 

Excess  Profits  Tax: 

As  a  credit 103 

Not  as  a  deduction 81 

Executors  All  of  Chap.  XII,  Page  87,  also  155 

Exempt  income: 

[APP.   P.  3   L.   L.  41-47] 

Bequests 62-64 

Compensation  of  present  President  of  the  United  States ..62 

Compensation  of  State  officers  and  employees 62-67 

Compensation  of  United  States  Judges 62 

Devises    62-64 

Gifts    62-64 

Interest  on  farm  loan  securities 62-65 

Interest  on  loan  to  buy  exempt  securities 80-248 

Interest  on  United  States  bonds 62-65 

Interest  on  State  or  Municipal  bonds 

Proceeds  of  life  insurance  policies ....62-61 

Exempt  organizations 

Domestic      190 

Foreign   

Exemption,  specific 

[APP.   P.  6,  L.  L.  84-90] 

Citizen  or  Resident ........4-105-378 

Non-resident   alien...  .-128 

Expenses  deductible 

Citizens  or  residents 68  to  78 

Corporations  (Domestic) —217  to  238,  also  324 

Corporations    (Foreign)  263 

Estates    ....163-164-165 

Non-resident,   aliens 

Extension  of  time  for  filing  returns 117-294 


8  INDEX 

Failure  to  make  return: 

Agent  of  individual 119-120 

Corporations 298 

Individuals  119 

Failure  to  make  return:    penalty 

Compromises     . 366 

Corporations    365 

Individuals     365 

Withholding    agent ....365 

"Fair  Market  Value"  as  of  March  1,  1913 ....37-214 

[APR.  P.  3  L.  L.  36] 
False  or  Fraudulent  returns;  penalty 

Corporations 365 

Individuals 365 

Withholding    agent 365 

Farm  loan  securities;   interest  exempt 62-65 

Farmers'   selling    associations 190 

Farms  and  farmers 45  to  54,  also  78-332-271-272-273 

Federal  Reserve  Bank  Stock ....200 

Fees  to  clergymen ; 22 

Fees:     professional 15 

Fidelity  bonds:    premiums  on 75 

Fiduciaries 

Decedent:    income  accruing  to,  to  time  of  death 170 

Estates  during  period  of  settlement ..164 

Trust    estates 165 

Trust  estate;  undistributed  income  of 166 

Tax  assessed  against 163-170 

Final   return  of  corporations 295 

Fire   insurance  premiums 77-78-238 

Fiscal  year  basis  for  corporations  and  partnerships: 

Assessment  and  notice  of  tax 353 

How  to  establish 287 

Returns,  when  to  be  filed....  ....288 

When  tax  is  to  be  paid  ...  ....354 

Foreign  corporations:    liability  for  return  and  for  tax, 

Branch    Offices 290 

Deductions  allowed  to 263 

Depletion  of  wells  and  mines 263  and  all  of  Chap.  XVIII 

Depreciation  263  and  all  of  Chap.  XVII 

Expenses 263 

Taxes 263 

Exempt    organizations ....194 

Extension  of  time  for  filing  returns 294 

Income   taxable 172 

Losses   263 

Returns 290 

Tax  Deducted  at  Source ....150-155 

Foreign   governments 320 

Foreign  items;  information  at  the  source ....158 

Foreign    partnerships 151 

Franchise  taxes  paid  by  corporations Page  135 

Fraternal   beneficiary   societies 190-199 

Fruit  Growers'  Selling   Associations 190 

Gifts  by  corporations 225-227 

Gifts: 

Exempt  from  tax 62-64 

Income  from  taxable....  ....62-64 


INDEX  9 

Good    will 211-277 

Government  bonds; 

Interest  from 62-65-330 

Corporation's  Supplementary  statement 297 

Partnerships  and  the  members  thereof 141 

•  Payments    in 330 

Gross  income: 

Corporations All  of  Chap.  XV,  Page  104 

Individuals  ...  ....All  of  Chap.  IV,  Page  22 

Guardians 119 

Head   of  f am i ly ;i05-106 

Holding    companies 184-337 

Holidays  in  connection  with  filing  returns 288 

Horticultural   organizations 190-195 

Husband,  and  wife 105  (c)-107-378-303 

Illustrative  Cases  (Income  Tax): 

Banker  Page  215 

Bank  stockholder Page  232 

Farmer  Page  218 

Holding  Company Page  233 

Investor Page  215 

Information  at  source Pages  223  and  226 

Lawyer Page  231 

Merchant  Page  227 

Millionaire    Page  225 

Physician Page  222 

Professional  man Pages  222  and  231 

Retired  man Page  229 

Salaried  man Page  226 

Tax-free  Bonds Page  229 

Wage-earner  Page  223 

Import  duties 85 

Income  tax  paid  if  Federal  not  a  deduction 81 

Income  tax  levied  by  a  state,  as  a  deduction 81 

Income  taxable 

All  income  of  ataxable  nature  to  be  returned 7-13,  also  Page  104 

Corporation    Page  104 

Foreign    corporations : 172 

Individual   (citizen  or  resident) 13 

Non-resident   aliens 125 

Paid  in  Liberty  Loan  Bonds 330 

Individuals: 

Accounting;  no  fixed  method 124-318 

Additional   tax 12-381-4 

Assessment  and  collection  of  tax Chap.  XXI,  Page  196 

Bookkeeping ;  no  special  system 124-318 

Compromises     366 

Credits  for  normal  tax All  of  Chap.  VII,  Page  57 

Deduction  of  tax  at  source 148-149-153-154-155 

Deductions  allowed All  of  Chap.  VI,  Page  43 

Depletion  of  mines  and  wells All  of  Chap.  XVIII,  Page  149 

Depreciation  deductible All  of  Chap.  XVII,  Page  139 

Dividends  25  to  31 

Expenses  deductible. 68  to  78 

Income;  gross . All  of  Chap.  IV,  Page  22 

Income;   net .—1 

Information  at  the  source 158 

Interest   deductible 80-334 

Liability  to  File  Return 2-303-376-377-379 

Losses  deductible....  -.89  to  97 


10  INDEX 

Partnership  interests 57 

Penalties    365 

Returns  All  of  Chap.  VIII,  Page  61 

Taxes  deductible 81  to  88,  also  334 

Indebtedness;  bonded  and  otherwise  (corporations) 

....235-245-246-248-254-255-258-259-260-343 

Information  at  the  source 158 

Inheritance    taxes    83 

Injunction  to  restrain  assessment  or  collection  of  taxes 312 

Insane  persons 

Delay  in  payment  of  tax 359 

Returns  for 119 

Insolvent  persons;  delay  in  payment  of  tax 359 

Installment   payments 346 

Installment  payment  of  taxes 362 

Insurance;    accident 

Insurance:   commissions  paid  agents 21-76-222 

Insurance  companies: 

Life   companies 202-262 

Mutual   Casualty 202-262 

Mutual  Employers'  Liability 202-262 

Mutual  Fire 202-262 

Mutual  Marine ...202-262 

Mutual  Workmen's  Compensation 202-262 

Reserves    203-262 

Forms    for    returns 

Supplementary    statements -296 

Insurance;  life:     proceeds  of  policies 62-63 

Insurance;  life  premiums  not  deductible 77-349 

Insurance    premiums ....77-238 

Interest  accrued  on  bonds  at  time  of  purchase 310 

Interest;  bank  deposits: 

Deductible  by  bank... 

Taxable   income 

Interest;  bonds'  of  exempt  organizations ...317 

Interest;  collateral  subject  to  sale  or  hypothecation 235-258 

[APR.  P.  13  L.   L.  192] 

Interest  deductible 

Corporations  ....248  to  261,  also  343 

Foreign   corporations —.263 

Indebtedness  secured  by  collateral  subject  of  sale  or  hypothecation 

235-258 

Individuals  

Non-resident    aliens 

Preferred    stock.. 257 

Stock  without  par  value 252 

interest;  deduction  of  tax  at  the  source: 

Citizens  and  residents 

Corporations     (foreign) 

Non-resident   aliens 

Partnerships  ..  ....151-152 

Inventories 

Judges  of  the  United  States:   compensation  exempt 

Labor    organizations. 

Last  due  date  for  filing  returns 111—288 

Lawyer's  fees : 15-76-220-329 

Lease,  improvements  under..... 325 


INDEX  11 

Leased  properties  operated  by  corporations 216 

Legacies:    income  from 62-64-324 

Legal  holiday  in  connection  with  filing  returns 288 

Lessee  and  lessor  corporations 216 

Liability  to  file  return: 

Corporations   (domestic) 176  to  188 

Corporations    (foreign) -. 189 

Estates    169 

Individuals 2-303-376-377-379 

Non-resident  Aliens 125-133 

License;  for  collecting  foreign  items 158-365 

Life  insurance  carried: 

Corporations  on  lives  of  officers  or  others 349 

Partnerships  on  lives  of  members 349 

Life  insurance  companies  (See  Insurance  Companies) 

Life  insurance  premiums 77-349 

Life  insurance  policies: 

Dividends  paid  on 63 

Proceeds  of 63 

Limited  partnerships  held  to  be  corporations 31-185 

Profits  of,  considered  dividends 31 

Liquidation  of  corporations 181-188-328 

Living  quarters,  part  of  salary 17 

Lobbying    expenses 233 

Local  benefits;  taxes  assessed  against 81-82 

In  connection  with  cost  of  property 214 

Lodges    190-199 

Lodgings  in  lieu  of  rent 24 

Loss  defined  in  connection  with  sales 89-90-92-93-94 

Losses  deductible: 

Citizens  or  residents 89  to  97 

Corporations 239  to  247 

Depletion,  by All  of  Chap.  XVIII,  Page  149 

Depreciation,  by All  of  Chap.  XVII,  Page  139 

Foreign    corporations 263 

Non-resident   aliens 130 

Obsolescence 266 

Maintenance  to  wife 44 

Mercantile  corporations;  gross  income  of 341 

Mileage   19 

M  i  nes ;   depletion  of 280-281-282-284-285 

Mines  operated  on  royalty  basis 342 

Minors:    returns   for 119 

Miscellaneous  corporations,  gross  income  of . 204 

Monthly  list  returns..— ....155 

Mortgage  indebtedness:    Assumed  by  a  municipality 66 

Mutual  insurance  companies 

Certain  ones  exempt 190  (sub.  Par.  10) 

Return:    forms  for  making ....292 

Mutual  savings  banks 190   (sub.  Par.  2) 

Mutual  telephone  companies 190  (sub.  Par.  10) 

National  guardsmen:    salaries  paid  while  in  service 223 

Net  income: 

Corporations    1 

Individuals  .. 1 


12  INDEX 

New    buildings 72-218 

Normal  tax: 

Deduction  of,  at  the  source 147  to  157 

Dividends  not  subject  to 26-104 

Estates     163-164-165-166 

Individuals  (citizens  or  residents) 4-10-11-380 

Non-resident   aliens 4-10-11-132 

Rates    11-380 

Notes  in   payment 336 

Notes,  interest  on;  at  the  source 149-158 

Obsolescence     266 

Ownership    certificates 148-156 

Paid-up  capital  stock: ...250  to  257 

Partnerships 

Business  expenses  of,  not  deductible  by  partners 70 

[APP.   P.  7  L.   L.  104-106] 

Deduction  of  the  tax  at  the  source;  none 151-152 

Dividends  to  be  credited  for  normal  tax  by  members 141 

Earnings  taxable  to  members  whether  distributed  or  not 57-139-140 

Fiscal  year 143-287 

Information  at  source ....145-158 

Income  from  partnership  accrues  when 140 

Liability    145-142 

Life  insurance  carried  on  members 146 

Limited  partnerships  held  to  be  corporations 31-185 

Returns  may  be  required  of 142 

Withholding    Agent....  ....145-155 

Patent   rights ....59-208 

Patents;   depreciation  of ...274 

Paying  agents  at  the  source 

Penalties: 

Collecting  foreign  items  without  license 

Corporations   

Deduction  of  tax  at  source 365 

Individuals  

When  claim  is  filed.... 

Pensions: 

Corporations  to  ex-employees ....56-226 

Paid  by  Government -—56 

Permanent    improvements ....72-218 

Philippine  Islands:   Application  of  law  to....  ....319-386 

Political    expenses 

Political  subdivision  of  state ....62-66 

Porto  Rico:  Application  of  law  to 319-386 

Preferred  stock  not  interest-bearing  indebtedness 

Premiums;    insurance 77-238-349 

President  cf  the  the  United  States;   compensation  of —.62 

Principal    place   of   business ,— - 

Private  banks  having  form  of  corporations — .  .... 186 

Professional  fees  taxable  in  year  received.. 

Profit  defined  in  connection  with  sales 34-35-36-37,46-214 

Property  acquired  prior  to  March  1,  1913 ....34-35-36-37-214 

Prorating     specific     exemption 

Public  utilities;  income  from  to  state,  etc ...315 

Publicity    of    returns ....-322-323 

Quarters  as  part  of  salary - -17 


INDEX  13 

Railroads  : 216-292 

Ranches;  income  from 45  to  54 

Rates    10-11-13-380-381-173-174-383-150-157 

Rates   of   exchange 309 

Real  estate  agents;  commisisons  paid  to 76-222 

Real  estate;   depreciation 271 

Real  estate;   interest  deductible  on  indebtedness 258-259 

Real  estate;   losses  from  sale  of 89-90-92-93-94-95-96-97-239-240-324 

Real  estate;   profit  from  sale  of 34-35-214-324 

Receipts  for  taxes 364 

Receivers    188 

Recoveries  on   bad  debts 200-206 

Refund   of  taxes  and  penalties , 368-369 

Statue  of  limitations 370 

Bar  removed  in  certain  cases 371 

Removal  of  buildings 244 

Rent: 

Board,  lodgings,  etc 24 

Crop  shares  47 

Expense    68-216-219 

Information   at   source 158-162 

Notes  in  payment  of 336 

Permanent  improvements  made 325 

Payments  consisitng  of  dividends  (lessee  and  lessor  corporations).. ..216 

Returnable   in   year   received 24 

Tax  to  be  deducted  at  source 149 

Repairs    73-229-264 

Representatives  having  receipt  an  dcontrol  of  income 135 

Reserves   for    depreciation 279 

Reserves,   in  general , 318 

Reserves;   insurance  companies 262 

Residence  defined 127 

Resident   aliens 125-127 

Retirement  of  bonds 246 

Returns  by  corporations: 

Accounts;  on  basis  on  which  corporation's  accounts  are  kept.. ..302-318 

Acknowledgments 289 

Amended   returns 299-122 

Bookkeeping;   no  particular  system 

Books  should  confirm  figures  on  return 318 

Change   of  name ! 187 

Contents  of  return Page  104   (first  par) 

Copy  should  be  kept 293 

Correction  of  returns - 299-122 

Examination  of  books  by  officers 321 

Exempt    income 29T 

Extension  of  time  for  filing , 294 

Fiscal  year  ...286-287 

Foreign    corporations    189-290 

Form   of   return 292 

Last  due  date  for  filing 288 

Liability  to  file  return .-176  to  189 

Mailing  of  return 

Notice  of  failure  to  file 

Penalties  for  failure  to  file  or  for  false  returns..-  ....300-301-365 

Public  records;  can  be  examined  by  officers  of  states.... 

Receipt  for  filing  return 291 


14  INDEX 

Secrecy 322 

Specific  exemption;  none  to  corporations 175 

Supplementary   statement 296-297 

Tentative   return 295 

When  filed 288 

Where  filed 290 

Returns  by  fiduciaries: 

Decedent's  taxable  income  accrued  prior  to  his  death 170 

Estates  during  period  of  settlement 163-164 

Extension  of  time  for  filing 117 

Failure    to    file 120 

For    non-resident    alien 136 

No  return  of  income  not  exceeding  $3000  required 169 

Penalties 365 

Trust  estates 165 

Returns  by  individuals: 

Accounts;    on  basis  other  than  actual  receipts  and  disburse- 
ments    124-318 

Acknowledgments  116-347 

Calendar  year 110 

Correction   of  returns 122 

Credits : 102-103-104-108-109 

Deductions  of  tax  at  the  source 108-109-307 

Dividends  to  be  included ;...26-104 

Extension  of  time  for  filing 117 

Form  to  be  used 116 

Husband  and  wife 107-303 

Non-resident  aliens 125-133-134 

Notice  of  failure  to  file 120 

Penalites  for  failure  to  file  and  for  false  return 365 

Secrecy    322 

Specific  exemption  4-378-105 

Tax-free  covenant  bonds;  interest,  how  entered 304-148 

When   filed    Ill 

Where  filed 115 

Who  files  ..  —112 

Returns   by   none-resident   aliens 134-135-136 

Returns  by  partnerships  may  be  required ...142 

Returns  by  the  source 155 

Royalties;    mines   and   wells 342 

Royalties;  from  patent  rights  or  copyrights ....59-208 

Salary: 

Deduction  of  tax  at  the  source 149 

Information  at  source 158'-162 

Paid  by  corporations 221 

President  of  United  States 62 

Received 15-16 

School    teachers 62-67 

State   officers    and    employees 62-67 

United    States    judges ...62 

Sale  of  capital  assets ....34-35-36-214 

Sale   of  capital   stock...., ....205 

Sale  of  real  estate 35-37-214-346 

Salvage   243 

Scientific  organizations 190  (sub  par.  6) 

Scrip    dividends ...28 

Secrecy   of    returns 322 

Sickness: 

Extension  of  time  for  filing  return 117-294 

Return  made  by  agent 119 


INDEX  £5 

Shi  king  fund  earnings _ 207 

Source;  deduction  of  the  tax  at  source 147  to  157 

Specific  exemption 

Additional  tax;   relation  of  specific  exemption 305 

Applies  to  normal  tax  only  of  individuals 4-105-378 

Corporations;  none 175 

Death  of  husband  or  wife ...303-170 

Decedent  for  portion  of  tax  year L. :....'.. Q 170 

Dependent   children 105-106 

Estates  during  settlement 168 

Head  of  family.... 105-106-378 

Married   person ....105-106-107 

Non-resident  aliens .......I........... 128 

Prorating ._ 303 

Source;  claiming  exemption  at  source . .. 148:156 

Trust  estates,  income  not  distributed  annually 168 

State  levying  income  tax;   right  to  examine  returns......... ......... ...r .....323 

State  officers  and   employees 62-67 

Statute  of   limitations: 

Assessment  of   taxes 314 

Refund    claims .370 

Removal  of  bar  in  certain  cases 371 

Suits  for  collection  of  taxes 314 

Suits  for  recovery  of  taxes 313 

Waiving  of  limitation 314 

Stock   dividends .25-27-338 

Stock,   livestock 49-50-272 

Stock,    preferred „.. 256-257 

Stock,  without  par  value 252-256 

Stocks  and   bonds: 

Appreciation  in  value  not  evidenced  by  sale 311 

Assessment    on    stock .'. ,..: ...........;.;... 205-74 

Depreciation  in  value  not  evidenced  by  sale........;... : 311 

Dividends  „ ...............25-27-338 

Losses  from  sale  or  other  disposition  of 89-90-92-93-94-95-96-239-240 

.  Profits  from  sale  or  other  disposition  of .34-36-37-38-39-214 

Sold  at  discount.... I l.;i.J ....245 

Subsidiaries ...178-337 

Suits:   (Also  see  Court  Decisions) 

To    collect   taxes 314 

To  recover  taxes  wrongfully  collected ;.... 313 

To  restrain  assessment  or  collection  of  taxes......  ..: :. :...- 312 

Sundays  in  connection  with  filing  returns—. :.— : 288 

Supplementary   statement :.... :..: ; 296-297 

Surplus,    dividends    paid    from.. :....:... 339 

Tax     bills .,-. : ,~'- L.Li 353 

Tax--d«tkicted  at-  the  source. ... • ...147  to  157 

f^cl (m* and   payable ! '...'. 354-355 

Tax-free  covenant  in  bond:  '  •   v-  v  >' 

Deduction  of  the  tax  at  source.:-:.'-. ....:.: i.:......148 

Corporations    receiving    interest ...213-304 

Individuals  receiving  interest-.,... ,.:. ...148:304 

Taxes  paid  on  interest  are  not  deductible .260 

Taxability: 

„;-'     €iti-zens  or  residents...... 2-7-13  and  376  to  379 

Corporations 2-172-383 

Deceased    persons........ ..."— ....170 

Estates:   income  accruing  during  settlement.. 2-164 

Fiduciaries  .. : ..: 1 63  to  1  70 


16  INDEX 

Foreign  corporations . 2-172 

Non-resident  aliens 2-7-125 

Partnerships 9-139 

Trust  estates;   undistributed  income  of 2-165-166 

Withholding  agents  at  source 155 

Tax  period: 

Citizens  or  residents 110 

Corporations  286-287 

Non-resident    aliens 110 

Partnerships,    members    of 139-110 

Tax  rates: 

Corporations    i 6-173-174-383 

Deduction  at  source 157-150 

Individuals  4-5-10-11-12-380-381 

Tax    receipts 364 

Taxes: 

Assessed  against  local  benefits 81-82  and  Page  134 

Bank  stock  tax,  paid  by  banks .84 

Customs  duties  85 

Deductible   81-82-85-86-87-88  and  Page  134 

Excess    profits    tax 81 

Excise  taxes 88  and  Page  135 

Foreign    taxes 87 

Franchise  taxes 88  and  Page  135 

Income  tax,  not  deductible 81 

Inheritance    taxes 83 

Reserve  for  taxes 318 

Suits  to  collect  taxes 314 

Suits  to  recover  taxes  wrongfully  collected 313 

Suits  to  restrain  collection 312 

Tax  free  covenant  bonds Page  135 

Tenant: 

Additions  and  betterments  made  by 325 

Deduction  of  tax  at  source  on  rent 149-155 

Three-year  limitation 314 

Timber   lands 327 

Trust  estate:   Must  make  return 165  to  169 

Trustee;    compensation  as 23 

Trustees: 

For   non-resident   alien 

In  bankruptcy 189 

Two-year  limit  for  claims 370-371 

Undistributed  gains  and  profits  of  corporations 174 

Undistributed  income  of  trust  estates 165-166 

United  States  bonds;  interest  from  exempt 62-65 

Partnerships  and  the  members 141 

"United  States"  defined 319 

Wells;  oil  and  gas:  depletion  of ...280  to  283 

Widow  or  Widower 106 

Wife  (American)  of  non-resident  alien 127 

Wife's  income 303-107 

Witholding  a^nts  at  the  source  defined : 153 

Wages: 

Deductible    68-220 

Income - 13-15 

Information  at  source 158-162 

Women: 

Additional  tax  on  husband  and  wife....  ....303 


INDEX 


17 


Year: 


Death  of  husband ....303 

Returns  by  wife "..107-303 

Specific    exemption ....107 

Wife  (American)  of  non-resident  alien '.".'.1.21 

tax  year: 

Corporations    286-287 

Individuals    ....110 


EXCESS  PROFITS  TAX 


Abatement   410 

Abnormal   Profits \ Pages  235  and  236 

Administration   of  law "£L3 

Aliens    (non-resident) 387-395-405-414 

Aliens     (resident)  387-405 

Annual   return: 

Calendar    year '. 413 

Fiscal    year _ , 413 

Appeals   for    revision 410 

Assessment   and    collection 393-410-413 

Average: 

Capital    403 

Deduction,  can  be  applied 411 

Net   income 404 

Basis  of  tax: 

Capital  for  "pre-war  period" 394-402-403-404 

Capital    for    taxable    year 401-402-403-404 

Net    income 396-397-398-399-400 

No    capital .'. 409 

Nominal  capital 409 

Not  in  business 406 

Percentage  of  return  in  "pre-war"  period 404-405 

Business;  meaning  for  purpose  of  tax: 

All  businesses 391-392 

Exempt    businesses 388 

Professions    (included) 392 

Trade     '. 392 

Capital;  invested  capital: 

Average   monthly 403 

Bonds    -401 

Cash 401 

Cash  value  of  property 401 

Corporation;   capital  of 401 

Change    of    ownership 4T)2 

Individual;    capital   of 401 

Intangible    property 401 

Partnership;   capital  of 401 

Reorganization  402 

Stocks     401 

Tangible    property 401 

Claims: 

.    Abatement    375-410 

Refund    .  ....375 


18  INDEX 

Copies  of  old  returns  necessary: 

Corporations Li 400 

Individuals ....400 

Corporations: 

Appeal  for  revision... ..4H) 

Capital    '„. ..; 401 

Deduction .....:.. "...4'05-406-409 

Exempt 388 

Foreign .' '„ 395-401-405-414 

Net    income ! 396-397-404-415 

Percentage    of    return 404-405-410 

Return  to  be  filed -_ , ...393-413 

Returns,  copies  of 400 

Revision  of  tax _ 410 

Tax    year .393 

Deduction: 

Corporation ...40f> 

Fixed  part * ......405 

How   applied... 407-408-411 

Individual [ 405-406-407-408-409 

Maximum   percentage 405 

Minimum  percentage 405 

No    capital : 409 

Nominal  capital 409 

Not  in  business .406 

Partnership   '. ....405-406-407-408-409 

Percentage    applied. 404-405-406-407 

Variable    part .:..: :..„' 404-405 

Exempt:   Those  exempt  from  tax 388 

Foreign   taxpayers: 

Corporations    ;; '„..; 387-395-401-405-414 

Individuals     ..387-395-401-405-414 

Partnerships     .  387-395-401-405414 

Illustrative  Cases    Pages  251  to  254;  also  Pages  245  and  246 

Individuals: 

Aliens    (resident) 387-391-392-398 

Appeal  for  revision :.._ ; 410 

Capital    401 

Deduction , .405-406-409 

Exempt 388 

Net    income 396-398-404-415 

Non-resident    aliens ..395-405-414 

Percentage  of  return , 404-405-410 

Return  to  be  filed 393-413 

Return,  copy  of 400 

Revision  of  tax :. ....:.. ..410 

Tax    year 393 

Interest  on    Liberty   Loan    Bonds 415 

Invested  capital  (see  capital). 

Liberty    Loan    interest -.1 Hv»4 415 

Officers;  Federal,  State,  etc ...388 

Partnerships: 

Appeal   for   revision.. 410 

Capital    .' : :'.!•: 401 

Deduction !405-406-409 

Exempt :. 388 

Foreign .....395-405-414 

Liability   to   tax ...•. 390 

Net    income :..... 396-398-404-415 

Percentage  of  return ;. ....404-405-410 


INDEX  19 

Return  to  be  filed  .........................................................  393-41S 


Revision  of  tax  ...........................................  ......  41 

Tax  year  ....  .........  qtn 

....................................  a»a 

Period: 

Fiscal  vear  ...  qqq 

(tr.  ~  .  •  ----«----  ..................................................  ...  .................  3-33 

Pre-war     period  .........................................................  394 

Taxable  year  ....................................................................  •-     •  ,393 

Philippines     ..................  .  ...............  ..  ...........  .  ..................................  ;  .•   4^5 

Porto   Rico   ...  ...............................................  j  ......................................  '..   4HJ 

Return: 

When  to  be  filed....  .................  ....  ......................  _  ..........................          ......  393-413 

Where  to  be  field  ................................  .  .........  \  ...............................  "."393  413 

State  Officers  ..................  .  .........................  ...  ...............................  3gg 

Tax: 

Abatement  ...  ...........  .  ........  .  ......................  ;  ........  .  ...........  .  ...........  410 

Assessment    .......  .  ..........................................................  :....™ZZ:\"™.\\7Z"393-4l'3 

Appeal   for  revision  ......................................  .  ................  410 

Corporations   ..........................................................................................  "m        ..."393 

Credit   for  tax  under  old   law  .................................  .  ........  .  ............................  417 

Individuals    .............................  .  ............  .  ...........................  ....393-413 

Old  law  repealed....  ....................  ......  ...  ............................................  ......:  ......  .....417 

Munitions  tax  ...........  .  .........................  .....  ................  ....418 

Partnerships    .............................  ........  .............  .  ...........................  ....390-393-413 

Payment  of  ..........................................................  ....419 

Rates   ..............................  „  ............  407 

Revision    ..........................................................................................  ;  ......  ........  .....  410 

United  States: 

Definiton  of  ..  ..................................  .  ..............  ..  ............  ....;  .....  :".  ....................  -.  .........  414 

Officers   of   ..  ....388 


MISCELLANEOUS   TAXES 


Admissions 496-497-499 

Ale 1 ..; 519 

Automobiles 500-509-510-511 

Beer '. :....; 519 

Berths,    trains    and    vessels 487-492-493-494 

Boats;    pleasure  boats.. 512-513-514-515-516 

Brandy^ 517-518-521 

Cameras     508-509-510-511 

Capital  Stock  Tax 420  to  441 

Carbonic  acid  gas 528 

Chewing-gum 507-509-510-511 

Cigars    530 

Cigaretes : 531 

Cigarette  papers   _ 533 

Club  dues  496-498-499 

Cordials    520 

Distilled   spirits    517-518-521-522-524 

Documents  457  to  478 

Dues   (to  clubs)    ..  ....496-498-499 


20  INDEX 

Estate  tax 442  to  456 

Excise  tax  on  capital  stock 420  to  441 

Express    shipments    485-491-492-493-494-495 

Extracts    527 

Fermented  liquors 519 

Freight    shipments    484-491-492-493-494-495 

Gas ;   carbonic  acid  gas 528 

Graphaphones    501-509-510-511 

Insurance  policies  479  to  483a 

Jewelry    503-509-510-511 

Medicines    : 506-509-510-511 

Motor  boats  512  to  516 

Motorcycles    500-509-510-511 

Moving  picture  films 502-509-510 

Occupations    534-535-536 

Passenger  transportation  486-490-492-493-494-495 

Perfumes    523 

Phonographs    501-509-510-511 

Piano  players  501-509-510-511 

Picture    films    '. 502-509-510 

Pipe-line  transportation  489-492-493-494 

Playing  cards  469 

Porter,  fermented  liquor 519 

Proprietary  medicines  506-509-510-511 

Radio   messages    488-492-493-494 

Rectified  spirits  522 

Seats,    parlor   cars 487-492-493-494 

Sirups    527 

Soft  drinks  525-526 

Snuff 532 

Spirits,  distilled 517-518-521-522 

Sporting   goods   504-509-510-511 

Staterooms,  trains  and  vessels 487-492-493-494 

Steamship   tickets    466-486 

Telegraph  messages   488-492-493-494 

Telephone  messages 488-492-493-494 

Tobacco    532 

Toilet  articles  505-509-510-511 

Transfers  of  estates 442  to  456 

Vermouth  520 

Wines    .  ....520 


FOURTEEN  DAY  t^E 

RETURN  TO  DESK  FROM  WHICH  BORROWED 


This  book  is  due  on  the  last  date  stamped  below,  or 

on  the  date  to  which  renewed. 
Renewed  books  are  subject  to  immediate  recall. 


,      8AugWQ 

4UL29195HI' 

MAR  1  1  2001 



.  

, 

General  Library 
LD  21-100m-2,'55                                  University  of  California 
(B139s22)476                                                     Berkeley 

YC'  23213 


